A plan is forming with a slow-motion component, and everyone wants to get rid of MBS
In the minutes of the January 29-30 FOMC meeting, published yesterday, the Fed added some tidbits about how it wants to deal with its “balance sheet normalization.” These minutes are always the most mind-numbing repetitive prose available in the English language. They’re clearly designed to not ever be read by a human. So I sorted it out. Here we go.
Not a word about rate cuts; it’s all about hikes:
The Fed put the world on notice that it might remove the newly beloved “patient” when it comes to rate hikes:
Many participants observed that if uncertainty abated, the Committee would need to reassess the characterization of monetary policy as “patient” and might then use different statement language.
And it also discussed rate hikes, when and if, while there was not a word about rate cuts: “Several of these participants argued that rate increases might prove necessary only if inflation outcomes were higher than in their baseline outlook.”
And those that are little more eager for a rate hike: “Several other participants indicated that, if the economy evolved as they expected, they would view it as appropriate to raise the target range for the federal funds rate later this year.
The QE unwind is still on autopilot:
That the QE unwind would continue on autopilot at least until the next meeting was clear from the post-meeting Implementation Notes, released on January 30. And it was repeated in the minutes – same language as it has been since late 2017.
“The Committee directs the Desk to continue rolling over at auction….” Up to $30 billion in Treasury securities and up to $20 billion in mortgage-backed securities would be allowed to mature and roll off the balance sheet without replacement, same as before.
Fed is stunned the little-bitty QE Unwind got blamed for suddenly sinking the market.
For about a year, the markets totally brushed off the QE unwind. Suddenly, in late 2018 all heck broke loose in the markets. Wall Street blamed the QE unwind. This is still puzzling the Fed. They’d expected “some upward pressure” on yields of Treasury securities and mortgage-backed securities (MBS) “over time,” but they didn’t expect a selloff in stocks, junk bonds, leveraged loans, and other risky assets:
Participants raised a number of questions about market reports that the Federal Reserve’s balance sheet runoff and associated “quantitative tightening” had been an important factor contributing to the selloff in equity markets in the closing months of last year. While respondents assessed that the reduction of securities held in the SOMA would put some modest upward pressure on Treasury yields and agency mortgage-backed securities (MBS) yields over time, they generally placed little weight on balance sheet reduction as a prime factor spurring the deterioration in risk sentiment over that period.
However, some other investors reportedly held firmly to the belief that the runoff of the Federal Reserve’s securities holdings was a factor putting significant downward pressure on risky asset prices, and the investment decisions of these investors, particularly in thin market conditions around the year-end, might have had an outsized effect on market prices for a time.
Paying Interest on “Excess Reserves” works in controlling short-term rates, but reserves have to be large enough, requiring a larger balance sheet than before:
By paying interest on required and excess reserves after the Financial Crisis, the Fed shifted its “operating regime” in how it implements its interest rate policy. Reserves are on the liability side of the balance sheet, along with “currency in circulation” (paper dollars used and hoarded globally). They must be balanced by assets on the asset side. In other words, a higher level of reserves and currency in circulation require a higher level of assets.
The “effectiveness and efficiency” of this operating regime determine what size the balance sheet should decline to. The goal is to whittle down the reserves, and therefore also the asset side of the balance sheet to “no more securities holdings than necessary to implement monetary policy efficiently and effectively.”
The Fed notes, after looking at the evidence, that the “current regime was therefore effective both in providing control of the policy rate and in ensuring transmission of the policy stance to other rates and broader financial markets.”
The “staff” presents some options on how to handle the reserves:
These reserves have already dropped by $1.2 trillion from the peak and continue to drop. But how much lower should they be allowed to go?
Some recent survey information and other evidence suggested that reserves might begin to approach an efficient level later this year.
So “later this year” would be the earliest opportunity. In this respect, the “staff presented options for substantially slowing the decline in reserves by ending the reduction in asset holdings at some point over the latter half of this year…”
The Fed laments that “market commentary” blamed the selloff on the QE unwind.
Participants discussed market commentary that suggested that the process of balance sheet normalization might be influencing financial markets. Participants noted that the ongoing reduction in the Federal Reserve’s asset holdings had proceeded smoothly for more than a year, with no significant effects on financial markets.
The gradual reduction in securities holdings had been announced well in advance and, as intended, was proceeding largely in the background, with the federal funds rate remaining the Committee’s primary tool for adjusting the stance of policy.
Nonetheless, some investors might have interpreted previous communications as indicating that a very high threshold would have to be met before the Committee would be willing to adjust its balance sheet normalization plans.
So the Fed took a new approach: communicating its “flexibility” to halt the selloff.
Participants observed that, although the target range for the federal funds rate was the Committee’s primary means of adjusting the stance of policy, the balance sheet normalization process should proceed in a way that supports the achievement of the Federal Reserve’s dual-mandate goals of maximum employment and stable prices.
Consistent with this principle, participants agreed that it was important to be flexible in managing the process of balance sheet normalization, and that it would be appropriate to adjust the details of balance sheet normalization plans in light of economic and financial developments if necessary to achieve the Committee’s macroeconomic objectives.
When will the QE Unwind end? Wait… there’s a slow-motion component.
Pretty soon, the Fed is going to announce its new plan: “Almost all participants thought that it would be desirable to announce before too long a plan to stop reducing the Federal Reserve’s asset holdings later this year.”
But here is the slow-motion component. Historically, the biggest driver of the level of assets on the Fed’s balance sheet was “currency in circulation” on the liability side. Assets have always risen with the increase of currency in circulation, which is determined by global demand for paper dollars through the banking system. Since the Financial Crisis, currency in circulation has risen more sharply than before, as folks around the world began hoarding paper dollars, and so the assets on the balance sheet, even without QE, would have risen more sharply as well.
The Fed is now considering keeping assets flat after the QE unwind ends, even as currency in circulation continues to rise. This would by definition whittle down further excess reserves, but very gradually, and effectively continue the QE unwind on super-slow-motion:
A substantial majority expected that when asset redemptions ended, the level of reserves would likely be somewhat larger than necessary for efficient and effective implementation of monetary policy; if so, many suggested that some further very gradual decline in the average level of reserves, reflecting the trend growth of other liabilities such as Federal Reserve notes in circulation, could be appropriate.
In these participants’ view, this process would allow the Federal Reserve to arrive slowly at an efficient level of reserves while maintaining good control of short-term interest rates without needing to engage in more frequent open market operations.
Only “a few participants” disagreed with this strategy. Those few participants thought that after the QE unwind ends, rather than maintaining asset levels roughly flat for years to come, the Fed “should begin adding to its assets to offset growth in nonreserve liabilities [cash in circulation], so as to keep the average level of reserves relatively stable.”
Everyone wants to get rid of MBS
The Fed’s “longstanding plan” is to “hold primarily Treasury securities in the long run.” This seems to be the consensus. Participants commented that after the QE unwind ends, “most, if not all, principal payments received from agency MBS” should be invested in Treasury securities.
In fact, some participants thought it was “unnecessary” to retain the $20-billion-per-month cap for the MBS roll-offs; that all principal payments could be allowed to roll off, which could slightly speed up the process of shedding MBS, especially if a drop in mortgage rates causes borrowers to refinance their mortgages, which would speed up pass-through principal payments to the Fed.
My proprietary Fed Hawk-o-Meter quantifies and visualizes what the Fed wishes to communicate in the minutes. Read… My Fancy-Schmancy “Fed Hawk-o-Meter” Ticks Down, Still Red-Lines. In Passing, Fed Plants Seed for Removing “Patient”
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So the way this observer reads it, this is anything BUT bullish for risk assets.
Sounds as if QT may pick up the pace if the Fed allows ALL MBS to roll off each month.
Why? You can put lipstick on a pig all you want but the emperor still has no clothes. Every major central bank capitulated in January. They will QE ad infinitum and cut rates to zero or negative in an instant to levitate assets.
The capitulation was incredible. Sorry, but my Fed Dove O Meter is screaming bullshit at any hawkishness.
‘The Fed is allowing up to $30 trillion Treasurys and $20 trillion in MBS to roll off each month’
On CNBC re: Fed balance sheet. A laugh for WR.
I’m starting to think the market selloff in Q4 was ignited by China’s stepped-up capital controls, and not the Fed’s QT.
Wolf great work deciphering the open market committee. When I was in grad school, I did a text analysis of geopolitical topics and discussions in all the historical FOMC transcripts for fun in R since the ‘tm’ package had just come out. They only occasional mentioned international political events – much less than anticipated. I also counted how much they discussed inflation versus unemployment. Rarely ever mentioned unemployment in the transcripts I looked at.
Might you do an article on China’s capital controls? I’d love to learn more.
I second the vote on China’s capital controls….and punishments for them.
@frugal. My contacts who have interacted with FOMC members tell me the political “pressure” the FOMC feels is slanted towards full employment vs. inflation…not surprising really.
It was rate hikes effects in the Bond Market caused panic cause they claimed three more in 2019… If they even raise by 25 bps at this point in business cycle it will cause destruction in bond market like they have never seen. 45 % of IG Bonds are supposed to be in Junk already according to very recent Morgan Stanley research, that’s a dangerous powder keg they have to deal with accordingly
They aren’t raising rates in this cycle anymore realistically unless there is a plan to severely damage the economy but that doesn’t add up cause they clean the mess right after. QT stops end of March or end June, when ever it snaps, consumer debt levels and corporate debt levels all time high, look at price income ratio in most western countries, and the king of incredible housing inflation is China, Beijing has a Price To Income ratio of 46!!! Mortgage as Percentage of Income is 369 %
Germany Exports will only plummet more, Japan and South Korea, every single company exporting to China will suffer declines. Chinese people are dangerously highly indebted due to excess printing done by there government, inflation is running out of control. Most Chinese citizens have multiple loans just to get by and this has been happening for years already, the situation over there is very serious and not some media hype. There was troubling signs since 2015, nobody listened, consumer debt reached beyond its capacity in 2018, now it’s a run away train of hyper inflation waiting to happen. Either Inflation Crisis or Deleverage, and there leadership won’t deleverage. They Printed 3.23 yuan in January alone, don’t think the Fed and rest of the world aren’t noticing, they fully understand situation unfolding. Once they start devaluing the Yen, they will have to print a trillions of RMB a quarter just to keep banking system alive, and consumer inflation will have people barely be able to afford basic necessities, China is really dependent on Energy Imports, with RMB devalue, Energy will be much more expensive in a Country already flooded with debt and hardship.
It’sessential for China and the world that Venezuelan oil production starts up again. That will keep the price nice and low in hard times.
Most people look at the Vzla situation through warped ideology glasses, while stopping the suffering of the people and cheap oil are what’s important.
Cheap heavy oil to mix with US light oil before refining is important for gasoline being cheap in the USA, but that’s nothing compared to the Chinese need for cheap oil.
Very recently,a Chinese official reminded that since the RMB is pegged to the US Dollar,it is the USFR that is manipulating its Currency and NOT PBOC!
So, the next meeting will be to plan when to announce a plan, then?
“Almost all participants thought that it would be desirable to announce before too long a plan to stop reducing the Federal Reserve’s asset holdings later this year.”
My semantics parser is hung up on one ambiguity: Will they actually “stop reducing … asset holdings later this year”? Or will they merely have “a plan to stop reducing … asset holdings” later this year?
BTW, it is absolutely ridiculous that the global markets are more dependent upon this sort of central-committee Kremlinology than, say, actual workers producing and delivering goods and services to one another.
I read this phrase 20 times — depending on how I hold my tongue, it means something different. I finally settled on letting everyone else decide. But I tend to think, given other references in the minutes, that the plan will be announced “before too long” and that it will call for asset purchases to end “later this year.”
– No, the FED has used the words “stop reducing holdings”. That does not automatically mean “increase …. holdings”. But the words “increase ….. holdings” could be around the corner.
– It simply shows – IMO – that the FED is well aware that the US economy is “weakening”.
– Quite simple. This is FED speak for “If/When we are going to stop the shrinking of the FED’s balance sheet then we will announce that well in advance”. So, if they are going to stop shrinking the FED’s balance sheet is say december then they will announce that in say august.
– Bernanke did something similar in 2013 when he announced that the FED would taper. And Yellen followed up with tapering
– Yes, it’s ridiculous because the FED follows the 3 month T-bill rate and not vice versa.
“Patience”, “slight upward pressure”, “long-term improvement”. Is this a Central Bank or a dentist office?
More like the office of a proctologist(s)….many !
I should think Currency in Circulation is a key phrase, as it suggests a review of Gresham’s Law in our time. I’ve argued the point on a Vancouver Condo blog late in 2017 that Gresham’s law has morphed into the application of Housing as currency, as well as the Lysander policy of making currency large, difficult to move and transact, thus exposing the hoarders to their culpability.
Wolf, you’re now on somebody else’s watch list with that “to get rid of MBS” bit, the Middle East watch office.
Trump asked a rich investor for help and he said “stop attacking the Fed chief” so much for laments. The Feds micromanaging is not going to do anything to dampen volatility. Most of this is out of Feds control, and if Europe and Asia go into recession they will print money.
LOL, Wisdom Seeker, and a reader, following an informative post by Wolf. Along these same lines, Rick Santelli, CNBC, Feb. 19: the continuing VLIRPs, ZIRPs, and NIRPs by 1st world Central Bankers (he said that 25% of global debt exists as NIRPs; I’m not sure that we even need to closely define “global debt” here). This looks untenable on the face of it, but Santelli’s closing point was that pension funds and other retirement vehicles required to invest in this stuff, will have a growing underfunding problem….what to do…..only one thing to do: dump the poverty-line retirees into the laps of the governments.
The PBOC added over $1 Trillion (USD, not Yuan) in liquidity in January, and Chinese risk assets shot up accordingly.
At the end of the day, with the PBOC continuing to “do whatever it takes”, the Fed’s QT actions seem to me to be of secondary importance.
Maybe, but the Chinese currency and so its economy are also a bit of a walled garden I think. A lot of commenters above are curious on China, and I haven’t read an in depth look at the country for a while, maybe because the data is not obvious to get hold of, or because the country does not work in a way that easily transcribes to our understanding. Whatever, but it would be interesting to read about. In the meantime M. Pettis has something of a look at the US relationship, on China his view is
“For that reason, countries with too much debt don’t suffer debt crises if they can successfully manage these balance sheet mismatches through a forced restructuring of liabilities. China’s balance sheets, for example, may seem horribly mismatched on paper, but I have long argued that China is unlikely to suffer a debt crisis, even though Chinese debt has been excessively high for years and has been rising rapidly, as long as the country’s banking system is largely closed and its regulators continue to be powerful and highly credible. With a closed banking system and powerful regulators, Beijing can restructure liabilities at will.”
I am not very sure if that management is capable of redressing the various market imbalances that might exist across a country that size though.
He also looks at where the US might be in deficit/debt creation terms, but it is a long read.
Look into Price to Income Ratio… In theory, China’s Central Bank can hold liabilities to 80 Trillion if it wanted to, but if it costs 70 RMB for 2 litres of Milk for the consumer, your consumption levels plummets to crisis levels.
You can spin it how you want, but China’s Inflation is beyond anything I have ever seen in any developed country. In Beijing with a Price to Income Real Estate Ratio of 46, it’s the equivalent of Household in US making 100k a year, living and paying a mortgage on a 4.6 million house. Mortgage to Income Ratio is 368 % in Beijing, in theory it’s impossible to sustain and quite frankly how did they even get past 200 %. In Practice, it means loans on loans on loans and can only ever work in a scenario where banks are state owned. When you ow 4-5 times your annual salary in bank loans, and you keep going to the banks to get more loans and you keep getting approved, you do not need a PHd in Economics to understand the massive Inflation that has been happening. I honestly didn’t think it was that possible to screw up a country the way China has fucked itself.
Vancouver has a article every week on affordability, how it’s a crisis here, and Price to Income Ratio is 14… Wtf is 46 ? Forget Japan’s Lost Decade, they keep printing trillions of yuan every quarter, and within a year they have misery similar to Venezuela for the lower to middle class, the RMB will devalue at any time now and hyper inflation will ensue, it will cost them 30-35 % of GDP easily to fix banking system once it snaps and with that it’ll be hyper inflation crisis
Everything you’ve said is true, but it’s also true that:
1. China is hoarding gold and probably has the second largest cache in the world by now. That can solve a lot of liquidity problems.
2. There are entire ghost cities in China waiting to be occupied. If and when affordability becomes too great of a problem, the gubment will direct people to them, and like all good comrades, they’ll obey.
3. China can repatriate billions in wealth stored offshore by either directing state-owned enterprises to liquidate assets or through other means. A liquidity crisis can be further by avoided by devaluing the Yuan, which will happen in due course.
4. At the end of the day, China is a Command and Control economy. Prices will be whatever the PRC says they should be.
They (the CPC) either make it work, or they don’t. Their back is literally against the wall and if they fail, they will have “lost the Mandate of Heaven,” bullets to follow.
I spend much of every day tracking news in China and their surrounds. It’s nerve racking.
Top 10 Countries With Largest Gold Reserves
United States. Tonnes: 8,133.5. Percent of foreign reserves: 75.2%
Germany. Tonnes: 3,371.0. Percent of foreign reserves: 70.6% …
Italy. Tonnes: 2,451.8. Percent of foreign reserves: 67.9% …
France. Tonnes: 2,436.0. …
Russia. Tonnes: 1,909.8. …
China. Tonnes: 1,842.6. …
Per person the US has more than 12 times China’s gold. But Germany with about 40 % of the US gold has even more.
While enough gold can insulate an individual against a prolonged recession, it would be burnt through quickly by any country.
China’s is worth about a hundred billion or less than a hundred dollars per person. It is a significant prop to the yuan.
but no substitute for China’s huge trade surplus.
Thanks for the various replies. The closest I have got to China is via family who source antique imports from there on visits, so the stories they have to tell are anecdotal but limited. The price to income ratios and other figures, the ghost cities which at one point were a theme in the press, and whatever else can be gleaned from wherever, don’t add up easily to something understandable. I think Briny has it right, as I do know smaller versions of China style organisation, different theme/ideology but similar structure, they tend to gain something of their existence by being continuously on edge, or being continuously on edge is their result, it is hard to say which is first. That said, I really cannot figure out how close or accepted the relationship with the state is there, my experience is that you have to be very immersed in local society to understand how that works or how people really feel, if they think at all, or if it much matters what they think. For a country that size, and which is not open in media terms, it is maybe an impossible task.
Wolf, i have to say that i have not read anything as concise and accurate as your assessment.
Every single news bit and article published is and has been a biased skew of wishful thinking for the return of massive QE and slashing FFR rates back to zero. No one cares about the long term ramifications of such a policy, especially when it is not required. No one cares about the global and domestic debt to GDP levels.
Everyone seems to “forget” that that extreme QE and FFR rate suppression was so significant because of the severity of the GFC. Everyone forgets that the unwind (QT and FFR hikes in earnest) should have begun in earnest in 2015 during Ms Yellen’s tenure.
I hear some of the central bankers in Europe saying we shoulda, coulda, woulda…. But no one wants to implement and go through with it. Draghi is the perfect example. There was a window a year ago and he passed. Now it clearly is too late. This is classic addictive behavior. Procrastinating on the withdrawal and then lamenting that i shoulda, coulda, woulda……. Kicking the can down the road. There’s a definitive psychological aspect to this global behavior and it is motivated by greed.
There’s stuff out in the “news” claiming there’s a synergistic “shadow” rate of the combination effects of FFR hikes and QT. All kinds of weird theories flying around, about how QE has sucked the life out of the economy and the markets This is all posturing by the media with the express intention of skewing political and social bias back towards extremely loose monetary policy. The ultimate purpose is to extend and pump the equity market for another leg up. It’s much akin to a child throwing a temper tantrum every time he or she does not get what they want.
No one seems to care about anything anymore outside of the equity market. December proved that beyond a shadow of a doubt……And the saddest part is that “they” will most likely get what they want…. the persistence of financial asset bubbles for another leg up, to the detriment of everything else.
Confirmed, QT continues as planned. Just look at the numbers.
US Treasury Notes and Bonds (Notes/Bonds) decrease by 23.294 billion.
This does NOT yet reflect the SOMA reinvestments of 2/15 in the amount of
20.229 billion (in 3y, 10y and 30y).
Wait for the NY Fed numbers to confirm anything you’ve heard.
If I was a bank (lender) I would first suck you in by giving you cheap loans
(Low interest rates ) then after a few years I would raise interest rates (I’m greedy )so I could make more money ..for all you who believe the banks are here to save your ass they are not .QE this and no more rolls is all that realestate agents are hoping for ,dream on everyone is hooked on debt your debt imprisonment begins about 6 months ago .poor guy pays down a little principle then they raise rates ,pay down a little principle they raise rates .in that senario you will never ever pay off your mortgage ,
I epect the fed to keep raising rates for a long time ,oh and by doing this as long as they are the reserve currency they take over the wored economically, they wouldn’t even need the military to do it
Despite sheep haruspicy readings, central bankers continue to do the only thing they know, create more money!
Just got the latest forecast by the Fannie Mae Economic and Strategic Research (ESR) Group in my inbox. It expects 2.2% GDP growth in 2019 (down from 3.1% in 2018) and one rate hike mid-year.
The Fed’s in denial. There’s No such thing as removing liquidity in the ‘background’. They can use any word they want, it’s still deflating the bubble.
Wolf, can you comment on where the Fed gets the ‘money’ from to pay interest on excess reserves? Is it printed (AKA stealth QE) or paid out of profits generated from US Treasuries*?
*I prefer the term US Confetti. Using the word ‘treasury’ to refer to low yielding gov debt that can only be repaid with more debt is like referring to horseshit as the royal gems.
Here is how much the Fed paid the banks in 2018 in interest on excess reserves, where that money came from, and where the rest of the money went…
“…..letting the balance sheet shrink would release “good” collateral such as US Treasury securities, while reducing the excess reserves that commercial banks keep on deposit at the Fed……
…..Thus, a leaner central bank balance sheet, if it doesn’t result in a tightening effect, could justify a much higher policy rate in this cycle than currently being anticipated.”
Oh well, maybe not, but that explains some of the thinking and part of why the long end of the curve won’t budge maybe – everyone setting up for reliance on treasuries but no one actually using them much, no inflation, no pull for a higher yield? Note he says “good” , not just plain vanilla good.
Assuming IOER and T Bill Yield is about equal, then Excess Reserves in the Fed as actually cheaper and better for the banks to hold because there is about a 5% (increase in cost) in terms of NSFR (i.e. Basel III). Treasuries have 5% required stable funding while reserves have zero.
Therefore QT means the exchange of Excess Reserves for Treasuries to the Bank – then seen in that angle, it will reduce liquidity.
Regarding the “flat” yield curve; the steepener they are looking at is really another QE where the Fed will buy or/and transform its assets into more T bills. The effect will be lower short term rates. We savers will hate this but the banks will love it since their Net Interest Margins (NIM) will increase. Look for the Fed replacing MBS with T Bills.
Yes, I didn’t think it would not reduce liquidity, but somehow the thought seemed to be that pushing treasury collateral as leverage would have finance and business reformulate enterprisingly instead of just soaking up IOER. Trickle up economics ? Maybe they want finance to rely on the treasury market more to strengthen future issuance, or increase its depth of demand in case foreign buyers vacate.
I’m guessing though.
Stockman cuts through the crap and calls Powell pathetic, but there must be more to the dithering than political pressure. Somebody above pointed out that the economy is weakening, and the central banksters of the world know it very well. Hence more opaque lingo to keep us guessing…
So what you have is a financial system that still so fragile, more than ten years after the Panic of 2008, that it still needs trillions in price supports, the global economy can be held hostage unless the FIC gets its trillions in payoffs, and interest rates any higher than ZIRP threaten to bring the whole thing crashing down, which everybody is just waiting to happen anyway.
I’ll defer the appropriate stinging sarcasm for later.
Bullard – “Rate hikes, balance sheet reduction ‘coming to an end'”
“I think we’re in a good place today,” he said. “We had a lot of success. People said it couldn’t be done.”
If this is not strutting (akin to an arsonist talking about putting out the fire he started and we do not even know whether the fire is put out given the debt in system and sky asset prices) I do not know what is. When crimes are not punished (as in not fixing responsibility for policies) then criminals are emboldened and strut about as if they are King Kong.
It just goes to show the malaise of the financial system when arsonists are in charge.
“… we’ll be working … in a very careful way,” Powell said. “Markets are sensitive to this.” Powell
Analyzing Fed Speak, I think this means: “Markets are to be coddled above all other interests.”
Nothing new about that, ever since Greenspan.