Fed's Balance sheet

ok…

Why would the Fed want to divest itself of its huge list of assets that it bought to support the economy at the same time that it is raising interest rates?

Am wondering how disvesting lots of assets that it bought to stabilize the economy in the past, affects the economy?

Am confused about how destabilizing that can be?

Why both at one time. Who does this serve?

Help?

:^)

jan

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How would divesting assets affect interest rates if that were all that they were doing?

Is there some advantage for the fed governors, if disvesting and rate hikes happen at the same time?

Why together, and why now?

Reducing money in the economy by increasing the cost of money. Rate hikes raise the cost of borrowing, as is evident with the explosion in mortgage rates, which has the immediate effect of reducing spending in that sector. A knock on effect is a reduction in refinancing, which reduces money available through home equity loans. Car sales will fall. Retail should fall soon. Services will weaken. Etc. etc. until we reach a recession.

Stopping bond purchases has the same effect but in capital rather than consumption markets. Without the Fed acting as a source of demand in the bond market, demand begins to decline and prices begin to fall. Falling prices mean rising rates for bonds. This has the obvious effect of raising the rates on treasuries, but it also reverberates throughout capital markets. Look at TUP as an example of what we will start to see happening to some high debt companies. Refinancing expiring bonds by tapping bond markets again will be ruinous for some because of rising rates.

It extends even further than bankrupting zombie companies, the withdrawal of the Fed from the bond market will place enormous downward pressure on equities as the cost of money rises. Think about it. Ten year bond yields are still relatively low at ~ 4%, while the earnings yield on the S&P 500 is around 5%. Many individual companies are still trading at rich multiples, ie 84x eps for Amazon or 66x eps for Tesla, which means investors are still paying a very high price for very low earnings yields. At what rate does holding treasuries become more attractive than hold stocks yielding 5% or less, especially if the above hypothesized recession materially impacts earnings (just look at what declining ad revenues are doing to GOOG). Powell just told us rates are going a lot higher. How high is anyone’s guess but I wouldn’t be surprised to see 7-8% by next summer. That would give us a market PE of 12-13 for an equivalent yield on equities. We’re looking at the possibility of a 40% decline from here if Powell does what he says he’s going to do. That will finally snap the high net worth consumers pocketbooks closed. If inflation hasn’t been whipped by then, god help us all.

PP

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The Fed selling its bonds, aka quantitative tightening, or QT, drives down bond prices effectively raising interest rates.

Selling bonds is consistent with raising interest rates to cool inflation.

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Thank you. Pondering about who (if anyone, other than the Fed itself) benefit from a lighter balance sheet?

Lol, how are the members of the Fed board of governors, paid?

:upside_down_face:

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Is the fed actually selling bonds, or are they simply allowing bonds to mature at par and not reinvesting?

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Does it matter? They both accomplish the same thing. Namely, taking money out of circulation and reducing the money supply.

Monetarists should be thrilled at this approach to reducing inflation. After all, isn’t inflation caused by too much money?

–Peter

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There is no effective difference, other than not realizing the loss between par and the current value (and allowing the purchaser of the below par bond to recover that amount at maturity). But the point is that “selling” is different than “allowing to mature”. Selling actually needs a buyer to materialize, allowing to mature means that no immediate buyer needs to come to the table, rather that at the next treasury offering, that amount of bonds needs to be sold at auction.

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The Fed is an odd critter. They don’t pay taxes, so they don’t care about gains or losses on their bond portfolio. They exist only to regulate the economy and money supply. And they can literally create money out of thin air. Losses are completely immaterial to them. All that matters is how much of the money supply they can remove through this method (selling bonds they purchased earlier, or allowing them to mature without buying replacements.)

There are always buyers for US Treasury bonds. The bond market in general (including corporate bonds) is larger than the stock market. The article is a bit dated, but I don’t think the markets have swapped places in terms of size in the intervening years. And even if they have, both markets are large and active.

–Peter

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That’s exactly my point. The fed has LOTS and LOTS of treasury securities in their portfolio. Many trillions at this point. So if they desire to reduce that by $100B, they have many choices about how to do so.

  • They can allow $100B to mature, and I understand that this is their primary mode of shrinking their balance sheet right now. And when that $100B is transferred from the treasury account to the feds account, poof, they simply make it disappear.
    -OR-
  • They can sell $100B at lower than par. Most of what they own is below par because interest rates have risen across the board. And when the purchaser transfers the $100B to the feds account, poof, they make it disappear. But this means that they sold a bond to someone at 90 cents, or 95 cents (or whatever), and that someone will hold that bond to maturity, collect the interest, and have a 5 or 10 cent capital gain. That adds a little additional money (the capital gain) into the overall economy (leaving aside the argument that some might be purchased by folks outside the USA) someday in the future.

Now, I haven’t thought through all the capital flows, so it is entirely possible that it ends up a wash either way, maybe since the purchaser would otherwise buy bonds from treasury at a higher rate, and capture more interest and no capital gain? So it may make no difference either way?

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My point is that either way, using your example, they will have removed the same $100B from the money supply. Letting them mature means that they got rid of $100B face amount of bonds. Selling on the market might take $105B of bonds to get that $100B out of the money supply.

Which way they go may depend on what bonds they are holding. I haven’t looked into that. But my understanding agrees with yours that they are mainly letting bonds mature.

However, if they want to impact longer term rates, they probably need to sell. There may not be enough of those bonds maturing to have the desired impact.

—Peter

Has anyone here read Edward Chancellor’s new book on interest rates? Thought this recent interview with Chancellor was fascinating:

Excerpt:

"RITHOLTZ: So let’s talk about what’s been going on around the world. And here in the United States, we have inflation at its highest level in 40 years. How much blame do you assign to central banks for the current circumstances? How significant were those quantitative easing and zero interest rate policies to the current state of inflation?

CHANCELLOR: What do you think? I mean, pretty significant.

RITHOLTZ: I think it’s one of many things, but obviously a very big one.

CHANCELLOR: Yes. I mean, the inflation is complex phenomenon.

RITHOLTZ: Right. But we had massive fiscal stimulus in U.S.

CHANCELLOR: Yes.

RITHOLTZ: And then the closing and reopening. But within the long-standing environment of zero for a decade.

CHANCELLOR: Yes. So I think I mentioned quantitative easing becoming a dangerous addiction. Initially, that quantitative easing after the financial crisis, was a time where the sort of financial system was deleveraging. The money wasn’t really making its way to Main Street, besides Main Street was high unemployment, and so on and so forth. It’s different when by 2020, with the lock downs, and not just U.S., Britain and —

RITHOLTZ: Around the world.

CHANCELLOR: — around the world. You had I think $8 trillion of central bank QE or balance sheet expansion, and roughly, dollar-for-dollar increase in government spending. And then, obviously, people were just staying at home with their stimulus checks.

RITHOLTZ: Right.

CHANCELLOR: And they were going out and buy meme stocks, having looked up on Wall Street bets, which stocks to be targeting, and borrowing at 2% from Robinhood. And —

RITHOLTZ: So here’s the question, if artificially low rates helped get us into this mess, will raising rates help get us out of this mess?

CHANCELLOR: No. I’ll tell you why. I mean, the thrust of the book is that you’ve got yourself into a perilous position, too much debt, too much risk-taking, overinflated valuations, too little real savings, too much financial engineering, and too little real investment. And once you’re in that position, it’s very difficult to get out of it. Do you remember after the financial crisis that was commonly used this phrase “kicking the can.” And really for the last — you could say for the last 25 years or so, we’ve been kicking the can. And now, we’ve reached the point where we have inflation, as we say, and it’s more difficult for the central banks to come in and kick the can any further because they’re in danger of losing credibility."

RITHOLTZ: The can is kicking back.

CHANCELLOR: The can got bigger. It’s like sort of quantum can. Every time you kick it, it gets bigger and bigger, and bigger. So we’re now sort of sitting under a massive can…"

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So Chancellor is saying that we’ve been kicking the can down the road too long with low interest rates. I can agree with that.

And then his conclusion is that higher interest rates won’t help. So he is proposing to continue kicking the can?

That makes no sense at all.

I go back to simple rules. Like the first rule of holes. If you find yourself in a hole, the first thing to do is to stop digging. Translated to interest rates, If you find yourself with a problem caused by artificially low interest rates, the first thing to do is to stop keeping interest rates artificially low.

–Peter

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Thinking about some other threads re: blockchain/crypto/etc. in other categories, I just have to ask, how would that be accomplished on a Blockchain? :wink:

Only kidding…
'38Packard

By the way, this likely only applies to their treasury securities. It probably doesn’t apply to their mortgage backed securities. That’s because mortgages aren’t paying off early much anymore due to:

  1. Little to no refinancing going on due to higher rates.
  2. Fewer people moving due to higher rates.

Well, I wonder if he’s considering the fact that we haven’t tried it yet. We had negative interest rates, and now we still have negative interest rates (real rates). Maybe he feels that negative interest rates cause the problems he described, and only positive [real] interest could begin to unwind those problems?

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Don’t they have a lot of mortgages on their balance sheet too? It seems thst the bought some of the crap from 2008 credit crisis?

I doubt they bought all that much from 2008. Most of it probably doesn’t even exist anymore having been refinanced a number of times since then.

They do own a lot of mortgage backed securities. I am not sure how much they’ve divested yet, but it could be contributing to the lack of mortgage money out there, the money is buying “old” securities rather than chasing after "new ones.

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It seems like the Fed is a "public/private partnership. Some people say that public private partnerships give the public all of the risk and the private partners all of the gains.

So, I wondered… who pays the Fed Governors? And how much are they paid? Is this like a corpirate board where they are paid per meeting?

:upside_down_face:

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The Federal Reserve is self-funded. The vast majority (90%+) of Fed revenues come from open market operations, specifically the interest on the portfolio of Treasury securities as well as “capital gains/losses” that may arise from the buying/selling of the securities and their derivatives as part of Open Market Operations. The balance of revenues come from sales of financial services (check and electronic payment processing) and discount window loans.[167] The board of governors (Federal Reserve Board) creates a budget report once per year for Congress. There are two reports with budget information. The one that lists the complete balance statements with income and expenses, as well as the net profit or loss, is the large report simply titled, “Annual Report”. It also includes data about employment throughout the system. The other report, which explains in more detail the expenses of the different aspects of the whole system, is called “Annual Report: Budget Review”. These detailed comprehensive reports can be found at the board of governors’ website under the section “Reports to Congress”

Here’s some info. I was too lazy to go hunting into the Federal Reserve Reports to Congress.

'38Packard

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