What $45 Billion a Month Gets You
We will soon find out if the Fed has any surprises in store for us so let’s take a quick look at what the Fed owns. For some reason, this is one of my favorite regular reports.
The Fed has finally bought more than $2 trillion of treasuries. That is right about on pace with what is expected since I had them just over $1.9 trillion back in September. The total amount of debt outstanding has increased a little bit (I only include t-bills and treasury bonds/notes and exclude TIPS and any other entity that issues debt that counts as treasury debt for the debt ceiling purposes).
The Federal Reserve now owns 50% of all treasuries maturing between 10 years and 15 years. Some further congratulations appear in order for that achievement. There are barely $100 billion of treasuries outstanding for the public to buy. No wonder so many companies are issuing 10 years and longer. The Fed has created such a void of paper that pension funds and others that want somewhat longer dated assets need to fill with corporate dead. It probably means that at some point the 10 year point of credit curves should weaken (go wider) but for now there is so much demand that corporate spreads will do okay even with the new issue.
I can’t help but look at these numbers and wonder how we will ever get out, yet yesterday, Fama, a nobel prize winner, said that the unwind wouldn’t be a big deal. I guess he missed the doubling in yields that occurred just on the threat that the Fed would buy less than $45 billion a month.
The Fed doesn’t bother buying much at the front end of the curve (less than 3 years) because they can control that rate via Fed Funds and the promise to never raise Fed Funds again.
The Fed is earning about $68 billion of coupon income. Since they create money that is virtually all profit, which goes a long way towards helping our budget deficit since it all finds its way back to the treasury on a periodic basis. No wonder the Fed can afford so many research reports out of each and every branch. They have more money to play with than they know what to do with. Maybe Ben can find a way to get paid 2 and 20?
It is worthwhile pointing out that while the Fed only owns 18.5% of all treasuries, it gets about 33% of all coupon income. They have bought any bond with a big coupon leaving the rest of the world to trade the “on the run” bonds.
The Fed has aggressively bought high coupon, high price, long duration bonds. That gets them the most bang for the buck in terms of helping control rates, squeeze income oriented investors out of treasuries and into other assets, and maximizes the of “profit” they can distribute.
They have done a “good” job given their goals.
Will We Run out of Treasuries?
The Fed is currently restricted to holding no more than 70% of an issue. They have a long way to go, even at the longer end of the curve before running out of room. If they ever got “desperate” they could buy some t-bills, so I am not concerned about their ability to source bonds. Especially since they aren’t price sensitive and would like their buying to drive rates down even more than they already have.
What is the “End Game”?
There is no “end game”.
The best case is the Fed exits as bonds mature but we don’t have to worry about that for at least 3 years.
Our “base” case is that the Fed interrupts QE with brief bouts of “Operation Twist” whenever too many bonds get close to maturity. That way they can just avoid maturing debt if it is inconvenient to shrink the balance sheet. That is likely.
“Worst” case 1 is that the Fed winds up trying to figure out some way to forgive the debt. They just make it “disappear” which helps everyone. Even the congressional budget office would like that since it would reduce long term deficits dramatically since they don’t account for all the interest the Fed earns.
“Worst” case 2 is the opposite and is where the Fed has managed to somehow spark inflation and has to sell bonds hand over fist in some effort to stop it.
The “best” case is far more likely than either of the “worst” cases, but I think our “base” case of QE ad infinitum coupled with the occasional Operation Twist is the new “normal” for the U.S. treasury market.
Finally Bad for the Dollar?
Is all this QE finally bad for the dollar?
We are beginning to think that, yes it is bad for the dollar, but not for all the “financial repression” “loose monetary policy” concerns.
We are starting to think it is bad for the dollar as more QE money is flowing into investments outside the U.S.
Money has no borders (except for the money tech companies keep locked away in tax havens) and more QE money is likely to start sloshing around the globe as the U.S. stock market is starting to look rich relative to other markets. Even our corporate credit markets look rich relative to what you can get in Europe. And a couple trillion of Spanish and Italian bonds might look better on a relative value basis – all of which could put pressure on the dollar.
While we wait for the Fed’s latest activity, which we think will probably turn out to be mildly disappointing, we will ensure that we neither eat nor drive nor heat our humble office because that might trick us into thinking that we have inflation.
In fact, that reminds me that I have to deal with Obamacare on a “personal” level. We got our new healthcare bill. There were 3 lines of price increases totaling a bit more than 20%, but the one that got my attention was the “standard increase” of 15%. I am still trying to figure out what business gets a “standard” increase of 15%.
But fortunately there is no inflation so the Fed is free to keep overnight rates at zero, bond purchases constant, and they can hint that they are thinking about buying more, in spite of a lack of evidence, as we pointed out yesterday, that QE actually helps jobs.
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