Fed Securities Held Outright, chart by Mish

Progress looks meaningless but it has started. Let's step back and see how we got here.

Monthly Change in Securities Held Outright

Change in Fed Securities Held Outright, chart by Mish

We had an unprecedented surge in QE which the Fed intends to roll back, starting very slowly.

Monthly Change in Securities Held Outright Detail 

Change in Fed Securities Held Outright, chart by Mish

I created the above charts after seeing this Tweet.

And so it begins. The Fed’s securities portfolio saw its first meaningful reduction in recent days (quantitative tightening). pic.twitter.com/chdCNuad6A

— (((The Daily Shot))) (@SoberLook) July 8, 2022

At a weekly level, MBS looks like a bowl of spaghetti. So I used monthly averages.

Mystery? 

Fed owns a quarter of all outstanding Treasury debt & 1/3rd of agency MBS.
ECB & BoE each own just shy of 40% of their government bonds.
Bank of Japan, which is unique in having no intention of stopping its purchases, owns nearly 1/2 of Japan gov bonds.https://t.co/xQzsLdlIp7

— Linda Yueh (@lindayueh) July 10, 2022

I fail to understand the mystery. QE goosed asset prices on the way up and QT rates to do the opposite. 

The Fed added liquidity and artificially lowered mortgage rates. Now it's taking some of that back albeit very slowly.

Fed Statement 

On May 4, the Fed announced its QT Schedule. 

• For Treasury securities, the cap will initially be set at $30 billion per calendar month and after three months will increase to $60 billion per month. The decline in holdings of Treasury securities under this monthly cap will include Treasury coupon securities and, to the extent that coupon maturities are less than the monthly cap, Treasury bills. 
• For agency debt and agency MBS, the cap will initially be set at $17.5 billion per calendar month and after three months will increase to $35 billion per month. The Desk will reinvest into agency MBS the amount of principal payments from SOMA holdings of agency debt and agency MBS received during each calendar month that exceeds the cap amount for that month. 

Snails and Ants

Many people following various charts have complained the Fed is not shrinking its balance sheet.

It is. Slowly. The problem is that most treasuries mature mid-month, the rest at month-end. Week-to-week mortgages are extremely volatile. 

2/5... b/c Treasuries didn't drop for 2 weeks, it appears the truth is a "punch in the face" - i.e., Treasury bonds mature mid-month & end of month, & due to MBS purchases taking 1-3 months to settle (which create misalignments w/ pass-thru principal repayments), the bal sheet...

— Gordon Johnson (@GordonJohnson19) July 10, 2022

5/5... things or possibly mkt manipulation. Why? Well, as of this week the Fed's MBS holdings are down $30.6B from the Apr. peak. In short, if "don't fight the Fed" worked in 2020-21, it would seem the bulls may be in for a nasty go at it over the next few months. Caveat emptor. pic.twitter.com/YuJQaDz91r

— Gordon Johnson (@GordonJohnson19) July 10, 2022

I elected to watch monthly averages as a better measure of progress. QT rates to escalate soon from a snail's pace to an ant's pace.

Should the Fed move faster? I believe so. 

The Fed certainly had no qualms about blasting trillions of dollars lickity-split. 

I would not say that QT has lifted off in a "big way" but it has happened.

Meanwhile the free money to banks rolls in.  

Hooray, More Free Money

The Fed pays interest on all reserves. At the end of May, the total reserves were $3.318 trillion.

The Federal Reserve currently pays 1.65% interest on reserves IOR.

If the Fed hikes to the range of 2.25-2.50 percent as expected, then expect IOR to jump to 2.40%.

Q: On an annual basis, how much free money are we talking about?
A: 2.40 percent of $3.318 trillion is $79.63 billion!

Q: We are giving banks $79.63 billion in free money?
A: It's a moving target.

The IOR keeps rising but the reserve balances keep declining.

That $79.63 billion reflects a hike that has not taken place yet. If the Fed keeps hiking at a pace that exceeds QT, then the amount will rise further. If not, the actual amount of free money will drop.

For further discussion, please see Reverse Repos Hit a New Record High of $2.33 Trillion: Plus a Q&A on Free Money!

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