Markets already started to kiss that easy money goodbye.
By Wolf Richter for WOLF STREET.
Total assets on the Fed’s weekly balance sheet as of April 20, released this afternoon, declined to $8.955 trillion, roughly the same as on March 16 and below the levels of March 23 and April 13. Beyond the week-to-week ups and downs, caused by the peculiarities of Mortgage Backed Securities (MBS), which we’ll get to in a moment, the balance sheet has flattened out. Balance sheet growth has ended. QE has ended. That part of the marvelous show is over.
Since March 2020, when this whole money-printing orgy began, the Fed has increased its assets by $4.65 trillion, a mind-boggling amount of QE in the span of just two years.
QE was designed to repress long-term Treasury yields, mortgage rates, long-term interest rates of any kind, and to inflate asset prices. It thereby created the biggest wealth disparity ever, documented by my Wealth Disparity Monitor, based on the Fed’s own data.
But then raging inflation got in the way. And the Fed finally started “tapering” its asset purchases in mid-November. Tapering means that the Fed bought less of Treasury securities and MBS than it did before tapering, when it was increasing its assets by about $120 billion a month. After the tapering began this monthly increase began to shrink. Now the balance sheet is no longer increasing, tapering is finished, and QE has ended.
Now markets started to kiss that easy money goodbye. The bond market has been getting hammered since last year. The stock market has been getting hammered since January this year, and numerous stocks have imploded.
The Fed has also unwound and brought to zero numerous of its emergency measures that it had started in the spring of 2020, including its repos, which it ended in mid-2020, and its corporate bonds and bond ETFs, of which it never bought much to begin with. We’ll get to them in a moment.
Treasury securities flat at $5.76 trillion.
Since the beginning of March 2020, the Fed’s holdings of Treasury securities have ballooned by $3.24 trillion, to a total of $5.76 trillion. The balance has now remained roughly flat for several weeks.
In order to maintain the balance of Treasury securities at the current level, as maturing securities come off the balance sheet, the Fed buys new Treasury securities in the amounts needed to replace the maturing securities.
TIPS decline, accumulated Inflation Protection rises.
The $5.76 billion of Treasury securities include Treasury Inflation-Protected Securities (TIPS) and the accumulated Inflation Protection on those TIPS. The government compensates TIPS holders for CPI inflation by increasing the principal of the TIPS. The Fed tracks this “Inflation Protection” amount separately from the face value of the TIPS. On its balance sheet today:
- TIPS, face value of $381 billion, -$7 billion from March 16.
- Accumulated Inflation Protection on TIPS, $81 billion, +$4 billion from March 16.
The Fed’s sleight of hand with TIPS on market-based inflation expectations.
Since March 2020, the Fed’s proportionally huge purchases dominated the relatively small TIPS market and pushed the TIPS yields into the negative.
The TIPS yields are called “real yields” and form a factor in the “market-based” inflation expectations (such as the spread to regular Treasury yields) that the Fed cited in its statements to show that market-based inflation expectations were “well-anchored,” when in fact these “market-based inflation expectations” were the result of the TIPS yields that the Fed manipulated down with its purchases of TIPS.
With its purchases, the Fed pushed the 10-year TIPS yield into the negative throughout the pandemic. But the Fed has now stopped buying TIPS, and the balance of TIPS is declining on its balance sheet, and TIPS yields began to rise in January (from -1.1% at year-end) to just above 0% on April 19, the first time since March 2020 that 10-year TIPS yield closed in the positive, though for only one day.
Manipulating the TIPS yield to show that “market-based inflation expectations” were “well-anchored,” though inflation had already begun to rage, was one of the cleverest monetary sleights of hand.
MBS: $2.73 trillion, flat with March 16.
The Fed’s holdings of MBS dipped to $2.73 trillion on the balance sheet today, and was roughly flat with the balance on March 16. Since March 2020, the Fed has added $1.36 trillion in MBS.
MBS differ from regular bonds in that holders receive pass-through principal payments when the underlying mortgages are paid off after the home is sold or the mortgage is refinanced, or when regular mortgage payments are made. As a passthrough principal payment is made, the balance of the MBS shrinks by that amount.
During period of low and declining mortgage rates, such as during the pandemic, mortgage refis are a huge thing, and the passthrough principal payments become a torrent, and the balance of each MBS shrinks rapidly.
Conversely, the surging mortgage rates now have largely killed refis, and pass-through principal payments have slowed down.
In order to make up for those pass-through principal payments, the Fed buys large amounts of MBS in the “To Be Announced” (TBA) market. Before the taper, it bought over $100 billion a month to make up for the passthrough principal payments and to increase the balance sheet by $40 billion a month.
Now it is buying just enough MBS to fill in the estimated amount of passthrough principal payments in order to keep the MBS on its balance sheet level.
But there are two problems with it:
- The unpredictability of the passthrough principal payments
- The 1-to-3-month delay before the Fed’s MBS purchases in the TBA market settle.
Trades in the TBA market take one to three months to settle. The Fed books its trades after they settle. So when the Fed was three months into the taper, that’s when the first tapered MBS purchases started showing up on its balance sheet. This is delayed data. And the MBS on the Fed’s balance sheet kept rising at the pace of purchases two to three months earlier.
In addition, the timing of the passthrough principal payments and the settlement of the purchases don’t match from week to week. So the Fed’s balance of MBS jumps up and down from week to week.
By now, most of the delayed settlements of the taper MBS purchases have been booked, though there might still be some stragglers out there. And the balance of MBS, despite the ups and downs from week to week, is roughly flat with March 16:
Unamortized Premiums decline to $342 billion.
This is the net amount that the Fed paid in “premiums” over face value and in “discounts” below face value when it purchased Treasury securities, MBS, and agency securities in the market. The net unamortized premiums peaked in November 2021 at $356 billion and has now declined to $342 billion.
The Fed – along with everyone else that buys bonds — has to pay a premium to buy securities whose coupon interest payments exceed the market yield at the time. For example, when you buy a 10-year Treasury security with seven years of remaining maturity, and a coupon interest payments of 2.5% a year, while the 7-year yield in the market is 1.5%, you have to pay a premium over face value to get those 2.5% coupon payments for the remaining seven years.
The Fed books these securities at face value and books the premium separately. The Fed then amortizes the premium in a straight line to zero by maturity date. Which means the Fed writes off the premium over the life of the bond. These securities have a higher-than-market-yield coupon interest payment, and the amortization of the premium is smaller than the coupon-interest payment.
By the time a particular bond matures, and runs off the balance sheet, this premium has been amortized to zero, and there is no loss at maturity. In other words, the Fed is taking the losses of this amortization on a constant basis, while it is earning the higher coupon interest income that these bonds generate.
Repurchase Agreements (Repos) at zero:
The Fed is still offering repos but has raised the rate it charges to be unattractive (currently 0.50%), and there have been no takers since July 2020, when the balance fell to zero.
With these repos, the Fed lends cash to counterparties in the repo market, in exchange for collateral (Treasury securities or MBS).
Repos are in-and-out transactions. On their maturity date – the next business day for overnight repos, or longer for term repos – the Fed gets its cash back, and the counterparty gets its security back. Repos are a quick way for the Fed to send lots of liquidity to the markets and take it out when the repos mature.
Central-bank liquidity-swaps at near zero.
The Fed has been offering dollars to 14 other central banks via “central bank liquidity swaps,” in exchange for their currency, to provide dollars to those economies for their dollar-funding requirements. The Fed did this during the Financial Crisis in 2008-2010, during the Euro Debt Crisis in 2011-2013, and during the pandemic.
Almost all of those swaps have matured and were unwound, with the Fed getting its dollars back, and the other central banks getting the local currency back. Only a minuscule $233 million of swaps remain outstanding:
SPVs continue to decline.
Special Purpose Vehicles (SPVs) are legal entities (LLCs) that the Fed set up during the crisis to buy assets that it was not allowed to buy otherwise. Equity funding was provided by the Treasury Department, which would take the first loss on those assets. The Fed lends to the SPVs, and shows these loans and the equity funding from the Treasury Dept. in these SPV accounts.
The total amount of the SPVs dropped by 79% to $44 billion, from a peak of $208 billion in July 2020.
The PPP loans that the Fed bought from the banks account for $22 billion, about half of the total SPVs, down from $90 billion in July 2021. Over the summer and fall of 2021, the Fed sold all of its corporate bonds and bond ETFs into the hottest corporate bond market ever, and they’re gone (yellow columns, CCF). The remainder are the Main Street Lending Program ($12 billion), Municipal Liquidity Facility ($7 billion), and TALF ($2 billion):
In addition to having fueled the worst inflation in 40 years, the past two years of the Fed’s QE and interest rate repression have created the worst wealth disparity ever, based on the Fed’s own data on the distribution of wealth in the US. The ultimate outcome of the Fed’s reckless money printing are raging inflation and this:
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