The Federal Reserve’s Balance Sheet November 12, 2021 Update
Total assets on the Fed’s weekly balance sheet through Wednesday, November 12, are as high as $8.65 trillion, after ballooning by $4.3 trillion since March 11, 2020:
Despite galloping inflation, the Fed continues to add Treasury securities and Mortgage-Backed Securities to its holdings for the time being, but has stated that it would cut these purchases in stages, presumably beginning in November, and will stop adding to its holdings by mid-2022. Repos and liquidity swaps, as well as its holdings of corporate bonds, bond ETFs, and commercial paper, which it sold in recent months into one of the hottest bond markets in history, have already largely gone. QE is intended to depress long-term Treasury yields, mortgage rates, and other long-term interest rates, as well as increase asset prices. Except for the highest-risk junk-rated securities, nearly all corporate bond and loan rates are below the rate of inflation, which has accelerated dramatically this year.
Repurchase Agreements (Repos) with a zero balance:
The Fed is still issuing repos, but the rates have risen to the point that there are better bargains available, and no one has accepted the Fed’s offers since July of last year, when the balance fell to zero. With these repos, the Fed’s asset, it distributes cash in exchange for securities, providing a rapid mechanism to inject large amounts of liquidity into the markets. Repos are the inverse of the currently popular overnight Reverse Repos (RRP), a balance-sheet obligation through which the Fed drains currency from the market, now amounts to $1.68 trillion. Under pressure from the excess liquidity produced by QE, the Fed is employing RRPs to keep short-term rates above 0%.
Swaps of central-banks liquidity
The Fed has been giving dollars to 14 other central banks in return for their currencies through “central bank liquidity swaps” in order to supply cheap dollars to other countries for their dollar-funding needs. The Fed did this throughout the 2008-2010 Financial Crisis, the 2011-2013 Euro Debt Crisis, and the pandemic. Almost all of the swaps have matured and been unwound, with the Fed receiving dollars and other central banks receiving local currency. Only a small number of swaps ($328 million) remain outstanding.
Treasury securities have reached a total value of $5.5 trillion.
The Fed’s holdings of Treasury securities have increased by $3.0 trillion since the beginning of March 2020, to $5.54 trillion. TIPS totaling $436 billion are included (Treasury Inflation-Protected Securities, face value and inflation protection). By controlling the TIPS market and therefore influencing TIPS prices and yields, the Fed has ensured that market-based inflation indices, such as the 10-year Breakeven Inflation Rate, reflect only the Fed’s purchases and predicted future purchases, rather than any inflation expectations.
The value of MBS has zigzagged to $2.53 trillion.
The Fed’s portfolio of mortgage-backed securities have increased by $1.16 trillion since March 2020 to $2.54 trillion. Pass-through principle payments are received by MBS holders when the underlying mortgages are paid off (when the home is sold or the mortgage is refinanced) or are paid down with regular mortgage principal payments. The Fed purchases substantial amounts of MBS in the “To Be Announced” (TBA) market – roughly $120 billion per month – to replace the pass-through principal payments and then adds around $40 billion to its balance each month. These pass-through principle payments are volatile, relying heavily on refinances and mortgage payoffs from property sales. TBA trades require months to settle and do not correspond to the timing of pass-through principal payments.
SPVs are on the decrease. PPP loans have been terminated.
Special Purpose Vehicles (SPVs) are legal entities (LLCs) established by the Fed during the crisis to purchase assets that it was not otherwise permitted to purchase. The Treasury Department supplied equity capital, and it would bear the initial loss on those assets. The Fed lends to SPVs and records these loans, as well as equity investment from the Treasury Department, in these SPV accounts.
Five of the SPVs expired on December 31, 2020, including the CCF SPV, through which the Fed purchased corporate bonds and bond ETFs. The Fed sold all of its corporate bonds and bond ETFs into the hottest corporate bond market in history during the last several months, and they’re all gone now.
Total SPV amounts declined to $79 billion from a high of $208 billion in July 2020. PPP loans purchased by the Fed from banks account for $50 billion of total $79 billion. The remaining funds come from the Main Street Lending Program ($13 billion), the Municipal Liquidity Facility ($9.8 billion), and the TALF ($4.49 billion).
More about these programs we write here:
According to their Congressional charter, the Federal Reserve has three mandates. They must successfully support full employment, stable prices, and moderate long-term interest rates. The Fed has achieved its first goal: employment has been essentially maximized. The adjusted unemployment rate is significantly below the 20-year average, according to the two alternative employment measurements that take into account job opportunities and people willingly exiting jobs. Traditional employment indicators have mostly recovered after the pandemic. Alternative indicators indicate that the job market is in better shape than it has been in over two decades.
In terms of the other two, the Fed’s mission aims are still far from being met.
Inflation, as measured by CPI and the Fed’s favored measurement, PCE, is two to three times higher than it has been in the twenty five years. Market-implied inflation forecasts for the next five years have risen to 2.90 percent, over double that of the preceding 10 years. Consumer inflation expectations, as evaluated by the University of Michigan, are approaching 5%, which is also twice the rate of the previous 10 years. Interest rates on almost everything are significantly below average. The Fed Funds rate remains close to zero, with no plans to raise it anytime soon. Corporate yields and mortgage rates are also approaching all-time lows.
Former Federal Reserve Chairman Ben Bernanke thinks that every additional $6-10 billion in excess reserves held by banks (as a result of QE) is about comparable to decreasing interest rates by one basis point. The “Bernanke adjustment” to Fed Funds results in a 5% decrease in the effective level of Fed Funds from the current level. The federal debt-to-GDP ratio is currently 125 percent, up from 105 percent before to the pandemic and more than double the level prior to the financial crisis. To maintain such an unsustainable pace, the Treasury need low interest rates and persistent buyers of its debt. The Fed meets both demands by maintaining zero interest rates and purchasing $80 billion in Treasury notes each month.
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The views expressed in this document do not constitute research, are not investment or commercial advice, and do not necessarily reflect the views of all management teams. They change over time.