EC Discounting Policy Errors

Third, what the Fed is buying is problematic. Consider that it buys TIPS (Treasury Inflation-Protected Securities)? Is this really necessary? To the extent it has an impact, it will boost the breakeven, making it appear to be greater inflation expectations than investors may really have. The Federal Reserve bought $175 bln of TIPS between mid-March 2020 and the end of February 2021, when only $150 bln were issued. It owned 20% of the $1.5 trillion market.  It seems convoluted to both buy TIPS and then cite the breakeven as a signal of inflation expectations as Fed officials do.  

The Federal Reserve is also buying $40 bln of Agency MBS a month. Is this necessary?  At least two regional Fed presidents think not.  The housing market is strong without it. Many metrics are at their best levels since before the Great Financial Crisis. The minutes from the April meeting suggest this was not discussed. Over the longer term, the Fed has indicated a preference that its balance sheets only carry Treasuries. From reading the press, one would hardly know that the US federal government directly or indirectly supports around 70% of US mortgages.  

The dollar seems to be particularly sensitive to the small intraday changes in US yields. After the FOMC meeting minutes were released and some headlines made it seem as if tapering was discussed, yields jumped, and the dollar followed suit. However, within a few hours, the yields began unwinding their gains, and the dollar pulled back. The greenback's movement is not about the macro data or risk-appetites or the famous smile.  It is about interest rates. The four areas of potential policy mistakes  (timing of tapering, allowing money market rates to continue to fall, not following up with an increase in 20-year bond purchases, and buying TIPS, which distort the signal of inflation expectations, and agency MBS that supports a housing market that is booming like it was 2006) collectively do not boost the Fed's credibility as its asks business and investors to trust its judgment.    

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Read more by Marc on his site Marc to Market.

Disclaimer: Opinions expressed are solely of the author’s, based on current ...

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