There is much confusion, even accusations, over whether QT is really happening. Let's settle the issue.

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I have covered this issue before, and my answer was the same. This past week, Danielle DiMartino Booth was accused of being a shill for the Fed. 

She's not, I am not, and neither is Joseph Wang. 

Both Wang and Booth worked at the Fed. Wang is a former senior trader who handled QE trades for the Fed.

No Shill for QT

Please consider No Shill for QT by Danielle DiMartino Booth.

Recently, my integrity was publicly questioned. It was deeply unsettling. The accusations, and there were a handful, was that I was a “shill,” hawking the Federal Reserve’s policy of Quantitative Tightening (QT) even though, in truth, the Fed was still engaged in Quantitative Easing (QE). After the anger faded, replaced by benevolence for those who fundamentally misunderstand the Fed’s public blueprint (linked here) to phase in QT, the wordsmith in me took over.

The sheer level of misinformation swarming my Twitter feed and that of other “shills” for the Fed’s “fallacious” QT prompted me to reach out to Joseph Wang, who hangs his hat in Estonia these days. In his past life, Wang was a senior trader at the New York Fed. Yes, he does know a thing or two about the workings of the Fed’s balance sheet.

Fed is Not Buying Treasuries

The Fed’s Treasury portfolio continued to grow even after QE due to principal adjustments from TIPs, a type of Treasury intended to protect the investor from inflation by adjusting the principal of the security each month by CPI. For example, $100 principal invested in TIPs would be adjusted to $110 principal after a year of 10% inflation. The Fed’s $370 billion holdings of TIPs is increasing due to elevated inflation, which is also separately broken out as “inflation compensation.” That growth in turn shows up as small but steady increases in the total Treasury holdings.

Since the advent of QT, Fed Treasury holdings have dropped steadily at a rate equal to the monthly QT cap. Fed Treasuries holdings decline discretely on mid-month and month-end because those periods are the time of month when most Treasuries mature. Mid-month and month-end are also the periods when newly issued Treasury securities are settled, allowing investors to easily roll over their maturing holdings into newly issued Treasuries. The Fed also reinvests any maturing Treasury principal in excess of its QT cap into newly issued Treasuries.

MBS Holdings Really Are Declining

The Fed’s MBS holdings are decreasing, even if this is obscured by the sawtooth pattern of its holdings, which arises from the repayment and settlement schedule of MBS, wherein MBS bonds receive principal repayments on the 25^th of the month and newly purchased MBS settle on the 15^th of the month. The spikes in Fed MBS holdings arise from the settlement of newly purchased MBS; the declines are due to principal repayments. The Fed is still receiving MBS principal repayments each month that must be reinvested, so its MBS holdings continue to show periodic spikes even as overall MBS holdings are declining.

The Fed’s policy of settling MBS purchases within a three-month window adds another wrinkle to understanding Fed MBS holdings. The Fed is the largest investor in the MBS market and aims to minimize any potential disruption by postponing MBS settlement if it judges that postponement would improve market functioning. This means some of the increases in the Fed’s MBS portfolio could arise from purchases conducted three months ago, including purchases from reinvesting principal received the period between the end of QE and the start of QT. These delayed settlements are recorded as commitments to buy MBS and have steadily declined over the months. These commitments obscure the steady drop of Fed MBS holdings but will dissipate in a few months.

Just Wait for September

QT is taking place exactly as the Fed has telegraphed and the balance sheet declines will become more apparent in the coming months. Soon the QT pace will quicken, and all past-purchased MBS will have settled. From that time, the Fed’s balance sheet will clearly and steadily decline each month.

If you are interested in having a deeper understanding of how liquidity flows on the Fed’s balance sheet, you can check out my online course on the subject.

Thank you, Joseph.

One last note on MBS. If the Fed does deploy the nuclear option and sells MBS outright, which is doubtful, and incurs a loss, the law allows the Fed to amortize for 10 years said loss by way of a 1/10^th per year reduction in remittances it sends every one of those 10 years to the Treasury Department. As much as it might anger Elizabeth Warren, such an outcome would not mean the Fed was insolvent. Much more likely, as Powell has indicated, QT shifts to Treasuries making up for any MBS QT monthly deficit to offset what’s not satisfied under the cap due to insufficient prepayments.

Fed Balance Sheet Components 

Image courtesy of the Fed and Danielle DiMartino Booth

Accusing Booth of being a shill for the Fed is as preposterous as accusing me of the same thing. She is highly critical of the Fed, always has been, and even has a book on the subject.

Fed Up: An Insider's Take on Why the Federal Reserve is Bad for America 

Here's Booth's Book. Fed Up: An Insider's Take on Why the Federal Reserve is Bad for America 

Fed shill? So am I. Makes as much sense.

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