Saturday, June 15, 2024

Is the Fed Getting Cold Feet about the QE Unwind?

Curious things are happening on its balance sheet.

The last Fed meeting ended on September 20 with a momentous announcement, confirming what had been telegraphed for months: the QE unwind would begin October 1.

The unwind would proceed at the pace announced at its June 14 meeting. It would shrink the Fed’s balance sheet – “balance sheet normalization” it calls that – and undo what serial bouts of QE have done: gradually destroying some of the money that had been created out of nothing during QE.

The pace of the shrinkage would be $10 billion a month for the first three months, and then it would accelerate every three months until it hits $50 billion a month at this time next year. That was the announcement.

Reality Check

Thursday afternoon, the Fed released its weekly balance sheet for the week ending October 18. We’re now two and half weeks and three weekly balance-sheet releases into the QE unwind period. How much has the Fed actually reduced its balances sheet?

  • Total assets on Oct 4:  $4.460 trillion
  • Total assets on Oct 11: $4.459 trillion
  • Total assets on Oct 18: $4.470 trillion

You read correctly: Since October 4, the balance sheet gained $10 billion, all of it in the week ending October 18.

The Fed is supposed to unload $10 billion in October. But curiously, so far, it has done the opposite. This chart shows the balance sheet movements so far this year. Note the jump in the last week:

The chart below shows the Fed’s total assets over the entire QE period from before the Financial Crisis through the currently missing QE unwind. There was a mini-unwind after QE-1 and that was about it:

As part of the $10 billion that the Fed said it would shrink its balance sheet in October, it is supposed to unload $6 billion in Treasury securities and $4 billion in mortgage backed securities. How did that go so far?

Since October 4, the Fed has in fact added $176 million in Treasury securities and now holds $2,465.6 billion of Treasury securities of all maturities, a new all-time record high, and there is no sign of any unwind:

And even crasser: Since October 4, the Fed has piled on $9.8 billion in mortgage-backed securities, and there is no sign of any unwind either:

In fact, looking at the Fed’s Open Market Operations (OMO), the Fed’s “Trading Desk,” as it calls this entity, was very busy nearly every day in the MBS market, buying between $400 million to over $2 billion of MBS per day.

The Fed has done this since the end of QE in order to keep the MBS on its balance sheet about even. MBS securities constantly forward principal payments to their holders (as underlying mortgages get paid down or off), and unlike regular bonds, they shrink until they’re redeemed at maturity. To keep the MBS balance steady, the Fed has to constantly buy MBS. So this just continues its routine.

But clearly, there is no sign that the Fed has backed off from its purchasing activity – which leaves several possible conclusions:

  1. The whole QE-unwind announcement was a hoax to test how stupid everyone is. But I doubt this.
  2. The people running the OMO are on vacation and have been replaced by algos or interns, and they just keep doing what the folks now on vacation have been doing for years. I doubt this too.
  3. The FOMC told the public what it wants to have done but forgot to tell its own people at the Trading Desk. I doubt that too.
  4. There is willfulness in it – a sign that they’re not ready, or that they want to give the markets more time to get used to the idea of it, etc. And this could be the case.
  5. They’re seeing something that worries them, and they’re holding off for now to get a clearer picture. But I doubt this because their decision to commence the QE-unwind on October 1 was unanimous, and since then nothing of enough enormity has changed.

Whatever the reason, the announced “balance sheet normalization” is not taking place. The opposite is taking place.

By contrast, when QE was started in late 2008, the Fed kicked it off with an explosive vengeance. The folks at the Trading Desk didn’t dillydally around. In the 10 weeks between September 3, 2008 and November 12, 2008, they purchased $1.3 trillion of securities, ballooning the balance sheet by 144%.

Sure, some people may say that a few weeks are not enough time to judge the Fed on its QE unwind. But this is not something we’re going to ignore. And so far, the Fed is doing the opposite of what it said it would do.

Author: Red

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