The ratio of the Fed’s assets to GDP dropped to 21.9%, lowest since Q4 2019 and back where it had been in 2013.
By Wolf Richter for WOLF STREET.
Total assets on the Fed’s balance sheet declined by $19 billion in July, to $6.64 trillion, the lowest since April 2020, according to the Fed’s weekly balance sheet today.
Since peak-balance sheet at the end of QE in April 2022, the Fed’s QT has shed $2.32 trillion, or 25.9% of its total assets.
In terms of Pandemic-era QE, the Fed has shed 48.4% of the $4.81 trillion in assets it had piled on from March 2020 through April 2022.
QT assets.
Treasury securities: -$3.8 billion in July, -$1.57 trillion from peak in June 2022 (-27.1%), to $4.20 trillion, the lowest since June 2020.
During pandemic QE, the Fed had piled on $3.27 trillion in Treasury securities. It has now shed 47.9% of that.
The $3.8 billion decline was in line with the Fed’s recently lowered pace of QT for Treasuries to $5 billion a month. The $1.2 billion difference was the inflation protection that the Fed earned on its holdings of Treasury Inflation Protected Securities (TIPS), which is added to the principal of the TIPS, instead of being paid in cash.
But there was an interesting shift: All of the QT came out of its TIPS holdings:
On July 15, $10.9 billion of 10-year TIPS matured, consisting of $8.03 billion par value plus $2.8 billion in inflation protection, and the Fed got paid this $10.9 billion, and these TIPS came off the balance sheet.
But instead of replacing all or nearly all of these TIPS with new 10-year TIPS at the auction on July 24, it only purchased $1.4 billion of TIPS at the auction and replaced the rest of the matured TIPS with Treasury notes.
So the Fed’s TIPS holdings fell by $8.9 billion (to $419 billion, including $110 billion in earned inflation protection), while its holdings of Treasury notes and bonds rose by $4.4 billion. The rest rolled off the balance sheet as QT.
Mortgage-Backed Securities (MBS): -$17.8 billion in July, -$620 billion from the peak, to $2.12 trillion, where they’d first been in February 2021.
The Fed has shed 22.6% of its MBS since the peak in April 2022, and 45.1% of the $1.37 trillion in MBS that it had added during pandemic QE.
The Fed holds only “agency” MBS that are guaranteed by the government, 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 have plunged and mortgage refinancing has collapsed, and far fewer mortgages got paid off, and passthrough principal payments to MBS holders have slowed to 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 $15-19 billion a month.
If pass-through principal payments become a torrent again, as during a refi boom, the Fed would allow the MBS balance to fall by the entire amount of the pass-through principal payments, but any amount above $35 billion a month would be replaced with Treasury securities. In that case, total QT would reach $40 billion a month, the theoretical maximum under the current QT regime.
Bank liquidity facilities:
The Fed has three bank liquidity facilities. There was little activity in July. The Fed has been exhorting banks to start practicing using these facilities with “small value exercises,” or at least get set up to use them, and pre-position collateral so that they could use them quickly.
- Central Bank Liquidity Swaps ($0.0 billion)
- Standing Repo Facility, or SRF ($0.0 billion).
- Discount Window: $4.9 billion, down by $1.5 billion from a month ago. During the SVB panic, it had spiked to $153 billion.
The Fed’s balance sheet in relationship to GDP.
The Fed-assets-to-GDP ratio – so total assets divided by “current dollar” Q2 GDP (not adjusted for inflation) – fell to 21.9%, the lowest since Q4 2019, and back where it had first been in Q3 2013.
In the era before QE through 2008, the Fed’s balance sheet grew over the years roughly in line with the economy as measured by “current dollar” GDP (so neither the balance sheet nor GDP are adjusted for inflation).
The Fed’s main assets were overnight repos and T-bills. It used its repo market trading to keep the yields in the money markets near its policy rates.
The balance sheet (red in the chart below) grew mostly as a function of “currency in circulation” (paper dollars, blue in the chart below), which are a liability on the Fed’s balance sheet, and reserve balances (also a liability, not shown in the chart) which were influenced daily by the Fed’s repo market trading.
But repo market trading was within a range, and currency in circulation was demand based and grew roughly in line with current-dollar GDP. So the growth rate of the balance sheet closely tracked current-dollar GDP growth rate.
For example, at the beginning of 2003, the Fed’s assets amounted to $732 billion. During that year, its assets grew by 4.4% to $773 billion, while current dollar GDP grew by 4.8%. That’s roughly how it went year after year.
During that time through 2008, the Fed’s balance sheet ran near 6% of GDP. The bouts of QE during and after the Great Recession drove the ratio to 25% by December 2014. QE stopped at that point, and as the balance sheet remained flat while current-dollar GDP kept growing, the ratio fell. Then in late 2017, QT-1 commenced and ran through mid-2019, which accelerated the decline of the ratio, until it dipped below 18% in Q3 2019.
At that point, repo market rates blew out. This multi-trillion-dollar-a-day market made a mess. So the Fed decided to mop up the mess by supplying cash via repos and buying T-bills. By December 2019, the ratio had risen to 19%.
Then pandemic QE exploded on the scene, and the Fed-assets-to-GDP ratio spiked to 35.5% in Q2 2020 and revisited 35.4% in Q1 2022. Then QE stopped. And the ratio has declined ever since.
In July 2021, the Fed revived its Standing Repo Facility (SRF) that the Bernanke Fed had killed in 2009. The SRF is now standing by to prevent that kind of repo market blowout, and its mere presence soothes the money markets. So in theory, the Fed is now prepared to drop the balance sheet below 18% of GDP and let the SRF do its job as it had done in the era before QE.
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One of the lessons that wasn’t learned from 2008 was suppression of all volatility delays blowups. The fed needs to stop.
Say Wolf,
Thank you for this article.
Is there a scenario where the Fed reduces interest rates, but continues to let treasury securities trickle off the balance sheet? Or, is that a counterintuitive idea?
That Fed has already been doing that for 10 months. It cut by 100 basis points last year and continued QT. It’s the official policy that “balance sheet normalization” and monetary policy (interest rates) are independent.
It’s a miracle inflation hasn’t been higher since 2008.
Wolf, all the Fed seems to mention is “run off” in Quantitative Tightening. When the Fed does QT ( Quantitative Tightening ), are there any actually selling of the Assets from the Balance Sheet from the Federal Reserve or is it just Letting it Run Off ( Mature ) ?
There are a lot more Treasury securities maturing every month than the Fed wants to shed. Like in August, about $80 billion in Treasury securities mature and come off the balance sheet. So the Fed wants to keep the runoff at $5 billion, and it’ll replace $75 billion of the maturing $80 billion with new securities that it buys at auction. So from that point of view, there is no reason to sell. Obviously, it could decide to do QT faster and let whatever mature run off the balance sheet, and its balance sheet would shrink pretty fast.
But MBS is different. They’re not maturing, they’re coming off via pass-through principal payments, and those have been slower than the Fed wants, and the Fed has been talking about actually selling MBS to speed up the runoff.
Thanks Wolf.
Earlier FED was replacing maturing securities with similar kind longer dated securities.
The new twist you mentioned, “replacing 10-year TIPS with shorter duration i.e. Notes”, is this a shift FED talking about? They have been talking in some speeches. But did they explicitly made a policy?
The notes could be 2-year to 10-year. The shift I was talking about is the effort to get out of the TIPS faster. The Fed played a huge role in the TIPS market during QE, which pushed down the TIPS yield (the interest part) into the negative, thereby artificially pushing down the metric for market-based inflation expectations — one of the metrics the Fed looks at for signs of inflation. In other words, during QE it manipulated the metric it was looking at for signs of inflation expectations. I wrote about it at the time.