Did the Fed Experiment With a Mini-Taper and Fail?
The Federal Reserve has slightly slowed its asset purchases over the last few months. Was this a trial mini-taper?
If so, the results are not good news for the central bankers over at the Fed.
The Fed balance sheet stands at $8.56 trillion. That’s up by $108 billion from the prior month-end, but down over the past week by $8.7 billion. The chart below shows how the Fed Balance sheet has grown by instrument over the last 18 months.
The Fed autopilot buying targets about $120B in monthly purchases split by $40B in MBS and $80B in US Treasuries. As the numbers show, this is not exact, but an approximation. The latest month added $33B in MBS and almost $82B in Treasuries, offset by “Other” dropping $7B.]
Figure: 1 Monthly Change by Instrument
The Fed has not purchased$120 billion in bonds — the QE target — since July. In fact, the central bank has actually been slowing its net purchases since June.
Is it possible the Fed has done a quiet mini-taper to see how the market reacts to the withdrawal of liquidity? Interest rates have crept up and the yield curve has actually started to flatten. If this was a trial balloon, it’s not a good sign given the paltry “taper” that has occurred so far!
The chart below shows interest rates on 2, 5, and 10-year maturities this year. Interest rates have moved up quickly since mid-September even when the Debt Ceiling was still in place. What happens if/when the Fed has to taper more aggressively?
The “taper” so far has been in the $5-$10B range. This should not be enough to move the multi-trillion-dollar treasury market. Still though, when you compare the chart above to the chart below, it is hard to ignore the correlation between Fed buying and interest rate moves. Is the rest of the market responding to the actions of the Fed this closely? If the small deceleration is even having a marginal effect, imagine what a full taper could do to the overall market!
Figure: 2 Interest Rates Across Maturities
The table below shows the breakdown of holdings by instrument and the period over period change as indicated. The main takeaways:
- The balance sheet has grown by $1.41T over the last year
- The Fed evenly distributed its purchases over the last month
- In recent months the Fed has been targeting specific ranges (e.g. 1-5 year maturities)
- Evenly spreading out its purchases may be causing the yield curve to flatten as less focus has been placed on 1-5 year maturities which have been rising
- The spread between the 2 and 10-year reached as high as 1.29 on Oct 8 and has collapsed down to 1.07 as of Oct 28
It’s hard to know for sure if Fed buying is having that much impact on the market because there are so many factors at play. However, if the Fed buying less short-term debt led to the shrinking spread, that means the Fed is having a large impact on the Treasury market. This will spell trouble as tapering is set to begin within a few weeks. It will be interesting to see what part of the yield curve the Fed tapers first.
Figure: 3 Balance Sheet Breakdown
The chart below shows the relative (percent) distribution by product. While absolute values have increased quite significantly as shown in the table above, the distribution of holdings has only changed some. MBS made up 40% of the balance sheet 3 years ago, but the number has fallen to under 30% as short term (<1 year) and medium-term (5-10 years) has increased from 10% to 14% and 6.4% to 11.8% respectively. These numbers continue to move up each month.
Figure: 4 Total Debt Outstanding
Zooming into weekly
Another chart to look at is the weekly change in the balance sheet. Anyone who follows the balance sheet closely will notice it dips once a month before jumping back up. The chart below shows how the fed balance sheet changes week over week. As seen, there are a few consistent trends:
- A series of MBS Mature about every four weeks
- This results in a slight decrease in the balance sheet for that week (this occurred in the most recent week)
- A bulk of MBS is also bought every 4 weeks that is larger than the maturing MBS
- This creates a surge in the balance sheet for that week
- Treasury securities mature and are purchased with less volatility
The latest week saw $19B in MBS mature versus $52B purchased last week.
Figure: 5 Fed Balance Sheet Weekly Changes
The table below shows how the latest week compares to the weekly averages over 4, 24, 52, and 156 (3 years) weeks. The weekly averages are shown to gauge whether the current periods (1 and 4 weeks) are accelerating or decelerating.
The Fed has averaged about $27B per week for 4 weeks which is less than the $30B and $27.1B over 24 and 52 weeks. There were 5 weeks in September which could be slightly skewing some of the numbers.
Figure: 6 Average Weekly Change in the Balance Sheet
The Fed is clearly monetizing US debt.
The chart below uses data from the debt analysis and matches it up with the Fed balance sheet holdings. While this is not a perfect one-to-one match due to the nature of reporting, the outcome can be seen below. This chart focuses specifically on Treasury securities: Bills (<1 Year maturity), Notes (1-10 years), and Bonds (10+ years). This is the bulk of debt issuance and Fed purchases.
As can be seen below the Fed has monetized a large percentage of debt issued since Jan 2020. The focus is clearly seen in Notes and Bonds to keep a lid on long-term rates. The first chart shows the debt added by the Treasury in each of the last 4 years by instrument. This shows very clearly how the Treasury has been rolling short-term debt to long-term debt in 2021.
The bottom chart shows the percent of that debt the Fed has purchased. In 2020, the Fed monetized more than 100% of notes and 90% of bonds. In 2021 those numbers have fallen to 32% and 45% respectively.
Who is going to absorb all this debt issuance if the Fed tapers? Who can absorb almost half of the long-term debt the Treasury will be issuing for the foreseeable future? This is why the Fed will be so delicate with tapering and inevitably increase it as spending in Washington continues unabated!
Figure: 7 Debt Issuance by Year and Instrument
Figure: 8 Fed Purchase % of Debt Issuance
The final plot below takes a larger view of the balance sheet. It is clear to see how the usage of the balance sheet has changed since the Global Financial Crisis. The tapering from 2017-2019 can be seen in the slight dip before the massive surge due to Covid.
There is no way the Fed will come close to shrinking the balance sheet at this stage. With more fiscal spending on the horizon and an economy addicted to low-interest rates, it is probable that the growth of the balance sheet will accelerate rather than decelerate.
Figure: 9 Historical Fed Balance Sheet
What it means for Gold and Silver
The Fed is in a box. They cannot let interest rates rise or else the entire economy will come crumbling down, but if they keep the monetary stimulus flowing then inflation will most likely spiral. As shown above, they have monetized a huge amount of the US Debt this year (~40%). The government needs this monetary support or else rising long-term rates will put pressure on the federal deficit.
The Fed can talk about tapering and even make attempts to do so, but they will inevitably reverse course and begin expanding their balance sheet by more than $120B a month. This will continue driving the Money Supply higher putting downward pressure on the dollar and upward pressure on inflation. Do they have the tools to fight inflation? Absolutely. But the implications of doing so are so politically devastating that they will choose higher inflation over a collapsing economy. Gold and silver will provide excellent protection during this time.
Data Updated: Weekly, Thursday at 4:30 PM Eastern
Last Updated: Oct 27, 2021