Standing Repo Facility (SRF) at zero, after doing its job calming the repo market at month-end.
By Wolf Richter for WOLF STREET.
QT ended on December 1, as per the Fed’s announcement at its FOMC meeting. But in November, QT continued, and the Fed’s total balance sheet declined by $37 billion in November, to $6.53 trillion, according to the Fed’s weekly balance sheet today.
Over the three years and five months of QT, the Fed shed $2.43 trillion in assets, or 27% of its total assets, and over 50% of the $4.81 trillion it had piled on during mega-QE from March 2020 through April 2022.
QT assets.
Mortgage-Backed Securities (MBS): -$16 billion in November, -$687 billion (-25%) from the peak, to $2.05 trillion, where they’d first been in November 2020.
According to the Fed’s new plan going forward, MBS will continue to come off the balance sheet until they’re gone, and will be replaced by Treasury bills (T-bills, they mature in one year or less).
The Fed holds only “agency” MBS that are guaranteed by the government (issued by Fannie Mae, Freddie Mac, Ginnie Mae), where the taxpayer would eat the losses when borrowers default on mortgages.
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 as mortgage payments are made. But sales of existing homes and mortgage refis have plunged, and far fewer mortgages got paid off, and passthrough principal payments to MBS holders have slowed to about $15-19 billion a month.
Treasury securities: -$4 billion in November, -$1.58 trillion (-27.4%) from the peak in June 2022, to $4.19 trillion.
Under the Fed’s new plan, as the balance sheet remains flat going forward, but MBS decline, while T-bills increase to replace MBS, overall Treasury securities will increase with the increase in T-bills. This will gradually shift the composition of the balance sheet from MBS to Treasury securities, with T-bills (now just $195 billion) becoming a larger part.
Bank liquidity facilities:
- Standing Repo Facility (SRF) had a zero balance again, see below.
- Central Bank Liquidity Swaps ($0.0 billion)
- Discount Window: balance ticked up by $700 million to $7.8 billion.
The SRF: The Fed has been exhorting its approved 40 or so counterparties, all of them big banks or broker-dealers, to use its new SRF, implemented in July 2021, to borrow overnight at it via repos and lend to the repo market overnight when yields in the repo market rise above the rate at the SRF (4.0% currently).
At the end of October, there was turmoil in the repo market as month-end liquidity pressures met with the government shutdown, which had caused the government’s checking account at the Fed, the TGA, to absorb $200 billion in cash that wasn’t getting disbursed, and repo market yields spiked.
Banks stepped in and borrowed at the SRF and lent to the repo market to profit from the spread. On October 31, the SRF balance hit $50 billion.
These are overnight repos that unwind the next business day, when the Fed gets its money back and the banks get their collateral back.
The month-end pressures abated in early November, and the SRF balance dropped back to zero. The SRF had done its job (my discussion of this episode is here).
But the Fed expressed its disappointment with the banks that they had used the SRF too little and too late, which had allowed repo market rates to surge too far above the upper end of the Fed’s policy rates, currently 4.0%.
At the end of November, the month-end liquidity pressures pushed up repo rates again, but not that much, and banks used the SRF, but not that much, with the balance peaking at $26 billion on December 1. Those overnight repos matured, and over the past two days, the SRF balance has been back to zero.
Without SRF, the repo market blew out in 2019.
Back in September 2019, after two years of QT, liquidity had become tighter in the repo market, and several things came together, including quarter-end liquidity pressures and corporate estimated tax payments, and repo market rates rose and then spiked, but banks didn’t step in and lend to the repo market to profit from it because they were tight on liquidity themselves as reserve balances had dropped during QT, and there was no SRF for them to borrow from because the Fed had scuttled its classic SRF in 2009 because it wasn’t needed during QE.
So repo market rates blew out and hit the double digits – in this $5 trillion-a-day funding market that many financial entities depend on. The odor of contagion was in the air.
The Fed then stepped in and engaged with the repo market directly, offering overnight and term repos. The amounts were big, maxing out at $257 billion at year-end 2019. At the same time, it started buying T-bills to flood the banking system with reserves.
This episode of the repo market blowing out and essentially forcing the Fed to undo a big part of two years’ worth of QT in a few months taught the Fed a lesson: In July 2021, while it was still doing QE, the Fed reestablished the SRF. And this fall, the SRF did its job and prevented another repo market blowout.
What else…
“Unamortized premiums”: –$2 billion in November, to $227 billion.
With these regular accounting entries, the Fed writes off the premium over face value it had to pay for bonds during QE that had been issued earlier with higher coupon interest rates and that had gained value as yields dropped before the Fed bought them. Like all institutional bondholders, the Fed “amortizes” that premium over the life of the bond.
“Other assets”: -$14 billion to $30 billion. This $14 billion drop consisted mostly of accrued interest the Fed was paid on its bond holdings.
The Fed doesn’t have a “cash” account, like companies do; it creates money when it pays for something and destroys money when it gets paid, and so when it gets paid the interest that it had accrued, it destroys that money, and the balance sheet drops by that amount. When it accrues the interest before it gets paid, the interest amount to be paid is added to the balance sheet.
This account fluctuates up and down on a quarterly cycle, on these interest accruals and interest receipts, but has stayed in the same range for five years.
This account also includes “bank premises” and other accounts receivables and will always have a balance.
Fed’s assets as % of GDP.
Before 2008, the Fed’s balance sheet grew as a function of currency in circulation and more broadly as a function of the size of the economy and the banking system.
Powell said during the press conference after the October FOMC meeting that the size of the balance sheet as a percent of GDP was one of the indications that it was time to end QT.
But the structure of the balance sheet changed during the Financial Crisis because the Treasury Department’s checking account was moved from private-sector banks to the Federal Reserve Bank of New York. This Treasury General Account (TGA) is a liability on the Fed’s balance sheet. As a balance sheet always balances, this means that assets had to grow with that liability over the years. There are currently $908 billion in the TGA. The addition of the TGA during the Financial Crisis has permanently increased the size of the balance sheet.
The Fed-assets-to-GDP ratio dropped to 21.4% in November, as per Q2 GDP, since Q3 GDP has gotten tangled up in the government shutdown. Q3 GDP will be larger than Q2 GDP, and the actual ratio is therefore even lower.
If the Fed holds the balance sheet flat for some time after QT ends as the economy grows, this Fed-assets-to-GDP ratio will drop further. This also occurred in 2015 through 2017, when the balance sheet remained essentially flat, but the assets-to-GDP ratio declined because the economy grew.
And in case you missed it, the balance sheets of other major central banks as % of GDP: Amazing How Central Bank Money-Printing Reversed around the World after the Inflation Shock
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I wonder how the fed will roll off MBS when the housing market looks the way it does.
No problem. It’s has been doing it for three years.