Quantitative Tightening has shed 45% of Pandemic-QE. Bank liquidity facilities at or near zero.
By Wolf Richter for WOLF STREET.
Total assets on the Fed’s balance sheet declined by $42 billion in January, to $6.81 trillion, the lowest since May 2020, according to the Fed’s weekly balance sheet today.
During May 2020, the third month of its mega-QE, the Fed had added $510 billion in that month alone to its balance sheet. So at the current pace of QT, we’re going to be saying “the lowest since May 2020” for about another 4-5 months. By the time we can say, “the lowest since April 2020,” the balance sheet will have dropped below $6.66 trillion.
Since the end of QE in April 2022, the Fed has shed $2.15 trillion, or 24% of its assets. Of the $4.81 trillion heaped on the balance sheet during pandemic QE from March 2020 through April 2022, the Fed has now shed 45%.
QT assets by category.
Treasury securities: -$25.2 billion in January, -$1.51 trillion from peak in June 2022, or -26% since the peak, to $4.27 trillion, the lowest since July 2020.
The Fed has now shed 46% of the $3.27 trillion in Treasuries heaped on the balance sheet during pandemic QE.
Treasury notes (2- to 10-year) and Treasury bonds (20- & 30-year) “roll off” the balance sheet mid-month and at the end of the month when they mature and the Fed gets paid face value. Since June, the roll-off has been capped at $25 billion per month. About that much has been rolling off, minus the amount of inflation protection the Fed earns on its Treasury Inflation Protected Securities (TIPS) that is added to the principal of the TIPS.
Mortgage-Backed Securities (MBS): -$15.7 billion in January, -$522 billion from the peak, to $2.23 trillion, the lowest since May 2021.
The Fed has shed 19.1% of its MBS since the peak in April 2022. In terms of the MBS that the Fed had added during Pandemic-QE, it has shed 38%.
MBS come off the balance sheet primarily via pass-through principal payments that holders receive when mortgages are paid off (mortgaged homes are sold, mortgages are refinanced) and when mortgage payments are made. But sales of existing homes in 2024 have plunged to the lowest since 1995 and mortgage refinancing has collapsed, and therefore far fewer mortgages got paid off, and passthrough principal payments to MBS holders, such as the Fed, have become a trickle. As a result, MBS have come off the Fed’s balance sheet at a pace that has been mostly in the range of $15-17 billion a month.
The Fed only holds “agency” MBS that are guaranteed by the government and is therefore not exposed to losses if borrowers default on mortgages; the taxpayer would pick up those losses, not the Fed.
Bank liquidity facilities.
The Fed has five bank liquidity facilities. Four have either no balance at all or a balance that is essentially zero on the Fed scale, though they were heavily used after the SVB collapse. The latest addition to that essentially-zero list is the Bank Term Funding Program (BTFP):
- Central Bank Liquidity Swaps ($76 million)
- Repos ($0)
- Loans to the FDIC ($0).
- BTFP ($197 million).
Bye-Bye BTFP: -$4.2 billion in January, to $197 million, down from $168 billion.
The BTFP was conceived in March 2023 after SVB had failed. But it had a fatal flaw: Its rate was based on a market rate. When Rate-Cut Mania kicked off in November 2023, market rates plunged even as the Fed’s policy rates were unchanged, including the 5.4% the Fed paid banks on reserves. Some banks then used the BTFP for arbitrage profits, borrowing at the BTFP at a lower market rate and leaving the cash in their reserve account at the Fed to earn 5.4%. This arbitrage caused the BTFP balances to spike to $168 billion.
The Fed, infuriated, shut down the arbitrage in January 2024 by changing the rate and decided to let the BTFP expire on March 11, 2024, and no new loans could be taken out since then. Nearly all remaining loans, which had a maximum term of one year, have now been paid off.
Discount Window: -$132 million in January, to $3.1 billion. During the bank panic in March 2023, loans had spiked to $153 billion. Even this balance qualifies as “near zero” as the chart below shows.
The Discount Window is the Fed’s classic liquidity supply to banks. As of the rate cut in December, the Fed charges banks 4.5% in interest on these loans and demands collateral at market value, which is expensive money for banks.
Powell has been publicly exhorting banks to use this facility more often, and practice using it with small-value exercise transactions, and to even get set up to use it, which many banks apparently are not, and to pre-position collateral so that they can use it when they need to. But there is stigma attached to borrowing from the Discount Window, and banks are reluctant to do it.
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IIRC, in a previous article circa last year, you mentioned that you didn’t think the Fed would be able to reduce their balance sheet below around $5 trillion without something “blowing up.”
How far do you think the Fed cam go?
The 4.? Trillion government securities can continue to roll off, with the Fed receiving face value to zero. Why not?
Michael,
That’s not what I said. I didn’t say “without blowing up.” It has nothing to do with blowing up. It has to do with liabilities, such as reserves and ON RRPs.
Here is what I said – it’s a long complicated article, but below is a snipped that gives you a feel, and note that it applies if the Fed wants to stay within its “ample reserves” regime. But the Fed doesn’t have to stay within it. It now has the tools to leave it, which is what the current article said the Fed is able to do, if it chooses to do so. Or it could run below ample reserves and still be OK.
https://wolfstreet.com/2024/03/23/the-feds-liabilities-how-far-can-qt-go-whats-the-lowest-possible-level-of-the-balance-sheet-without-blowing-stuff-up/
The “lowest possible level” of the Fed’s balance sheet in 2026?
No one knows, not even Fed, but here is our guess: $5.8 trillion, limited by the liabilities.
The minimum balance sheet level is determined by the liabilities. In the current setup at the Fed of “ample reserves,” it’s the reserve balances that the Fed will watch. If reserve balances drop too low, as they did in 2019, bad things can happen. Let’s say this theoretically lowest possible level of ample reserves is $2 trillion in two years. Add a little margin of safety, so maybe $2.2 trillion.
In this scenario, this lowest possible level of the balance sheet in this scenario would be $5.8 trillion, below which the balance sheet cannot decline without something blowing up:
$2.2 trillion reserves
$0 ON RRPs
$2.38 trillion currency in circulation, tends to grow over the years.
$900 billion TGA
$350 billion foreign official RRPs.
Realistically speaking, getting the balance sheet close to $6 trillion by the end of 2026, so shedding another $1.5 trillion, after the $1.45 trillion that have already been shed, will be a big improvement, meaning that the Fed’s balance sheet will by then have shed about $3 trillion, assuming that nothing blows up along the way.
BTFP at $197M is just chump change now. They should just get it all off the books immediately. Therefore, I propose a win-win-win solution. Write it off and send me the notes that are due on. I’ll cut the banks a deal to pay me at 50 cents per. It’ll be a national victory. I’ll even toss in some hot dogs (chicken/pork only) for the celebration. (It might be $98.5M but I’m still staying on the cheap regardless.)
The loans have a term of 1 year and they stopped making new loans in March 24. Give it a month and it will all be gone.
Overall I think the Fed is doing a good job now. I just wish they were more aggressive in the early months of QT. I understand that now that most QT will come from bank reserves you have to go slower. But money in the overnight repos is much more liquid and they could have easily doubled the rate of QT for the first year and drained the ONRRP account much faster. Then they could have slowed down and give more time for reserves to adjust.
Even now, the Fed should gently nudge the banks to start reducing their excess reserves by slightly cutting the interest paid on reserves. Most of that excess money will flow into treasuries and other assets, allowing the Fed to tighten faster. Pushing banks to do so ahead of QT forcing their hand would prevent last minute surprises.