It sticks to plan, QT like clockwork: What the Fed did in details and charts, and my super-geek extra-fun dive into the “To Be Announced” market for MBS.
By Wolf Richter for WOLF STREET.
The Federal Reserve’s quantitative tightening (QT) completed its three-month phase-in period on August 31. During the phase-in of QT, the plan called for the Fed to allow its holdings of Treasury securities to drop by up to $30 billion per month by letting them mature without replacement, and allow its mortgage-backed securities (MBS) to drop by up to $17.5 billion per month, mostly from pass-through principal payments.
In September, the pace of QT roughly doubles with the caps doubling to $60 billion per month for Treasury securities and to $35 billion for MBS. So how did it go in August?
Total assets on the Fed’s weekly balance sheet as of August 31, released on September 1, dropped by $25 billion from the prior week, by $48 billion from the balance sheet of August 3, and by $139 billion from the peak on April 13, to $8.83 trillion, the lowest since January 12.
QE created money that the Fed pumped into the financial markets by purchasing securities from its primary dealers, who then sent this money chasing assets in the financial markets and in other markets, including residential and commercial real estate, all of which inflated asset prices, and drove down yields and mortgage rates and other interest rates, which was the express purpose of QE.
And in early 2021, QE suddenly helped fuel the raging consumer price inflation that the Fed has now set out to battle with rate hikes and, you guessed it, QT.
QT has the opposite effect of QE: It destroys money, pushes up yields, pulls the rug out from under asset price inflation, and contributes to bringing consumer price inflation back down.
QT is straight forward with regular Treasury securities, complicated only by the Fed’s holdings of Treasury Inflation Protected Securities (TIPS). But MBS are a different creature, as we’ll see in a moment.
Treasury securities: Down $76 billion from peak.
Treasury notes and bonds roll off mid-month and at the end of the month, when they mature. Today’s balance sheet includes the roll-off on August 31.
TIPS pay inflation compensation (income). But it is not paid like coupon interest. Instead, it is added to the principal value of the TIPS. When TIPS mature, holders receive the amount of original face value plus the accumulated inflation compensation that was added to the principal over the years (similar to your I-Bonds).
- Treasury notes and bonds: down $30.4 billion.
- TIPS Inflation Compensation: up $6.0 billion, earned and added to TIPS principal.
- Net change: -$24 billion from August 3 balance sheet.
This inflation compensation of about $1.5 billion a week is income that the Fed earns that will be paid in cash by the Treasury Dept. when the TIPS mature. The Fed adds this income to the balance of the TIPS weekly. You can see it in the chart below in the slight upward slope in the period after QE had ended in mid-March and through June 6, before QT started.
MBS, creatures with a big lag: Down $31 billion from peak.
We’re going to do some super extra special geeky stuff today, a WOLF STREET deep-dive into the Fed’s transactions of MBS in the To Be Announced (TBA) market that I uploaded to my server and that I will walk you through in a moment. This will without doubt be the most fun you’ve ever had. But before we get there…
MBS come off the balance sheet mostly through pass-through principal payments. When the underlying mortgages are paid off due to a sale of the home or a refi, or when regular mortgage payments are made, the principal portion is forwarded by the mortgage servicer (such as your bank) to the entity that securitized the mortgages (such as Fannie Mae), which then forwards those principal payments to the holders of the MBS (such as the Fed).
The book value of the MBS shrinks with each pass-through principal payment. This reduces the amount of MBS on the Fed’s balance sheet. These pass-through principal payments are uneven and unpredictable.
MBS get on the balance sheet 1-3 months after the Fed purchased them in the “To Be Announced” (TBA) market.
And that’s what we’ll have fun with now.
Purchases in the TBA market take one to three months to settle. The Fed books its trades after they settle.
I uploaded to the WOLF STREET server the spreadsheet that I downloaded from the NY Fed containing a portion of its MBS operations in the TBA market. To make the walk-through easier to follow, I color-coded the spreadsheet (download my spreadsheet “NYFed_MBS-ops” here).
The spreadsheet shows how each of the MBS are flowing into the Fed’s balance sheet, and how long the lag is for each MBS:
- I marked in red: all MBS purchases that settled in August (settlement date = Column J). They settled on Aug 11, Aug 16, and Aug 18.
- The Fed’s weekly balance sheet is always as of Wednesday, and is released on Thursday.
- MBS that settled Aug 18, showed up on the Aug-24 balance sheet, but they coincided with a big pile of pass-through principal payments that ended up overpowering the skimpy purchases and reducing the balance on that day.
- The MBS that settled on Aug 11 and 16 showed up on the Aug-17 balance sheet, and you see how the MBS balance rose.
- Now go to column C (yellow) “Operation date,” when the MBS were purchased in the TBA market.
- I marked the MBS that were purchased in June with bold red (column C). And they showed up three months later on the Aug-17 and Aug-24 balance sheets.
- Now go to what the Fed purchased in May, before QT, which I marked in green (column C = purchase dates). There are a lot of them, $108 billion (I added them up in column Y). Keep scrolling down all the way down to line 265 to see them all.
- In Column J (settlement dates), you see that the MBS that the Fed purchased in May, before QT, settled in June and July, during QT, which is when they showed up on the balance sheet. That’s why people thought that the Fed wasn’t doing QT.
Wasn’t this hilarious fun? I thought so!
The Fed is doing exactly everything it said it would do; you just have to understand the mechanics of the TBA market and the balance sheet.
MBS: down $31 billion from peak, to $2.71 trillion:
Unamortized Premiums: down $29 billion from peak, to $327 billion.
All bond buyers pay a “premium” over face value when they buy bonds when the coupon interest rate of that bond is higher than the market yield at the time of purchase for that maturity.
The Fed books securities at face value in the regular accounts, and it books the “premiums” in an account it calls “unamortized premiums.” The Fed then amortizes the premium of each bond to zero over the remaining maturity of the bond. At the same time, it receives the higher coupon interest payments. By the time the bond matures, the premium has been fully amortized, and the Fed receives face value, and the bond comes off the balance sheet.
The “unamortized premiums” peaked in November 2021 at $356 billion and have now declined in a steady process by $29 billion to $327 billion:
For your amusement, how we got to Raging Inflation:
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