Fed Absorbs $60B of 1 to 5-Year US Treasuries in September
The Fed keeps talk, talk, talking about tapering quantitative easing, but the balance sheet continues to get bigger and bigger and bigger.
The Fed balance sheet stands at $8.45 trillion, up by$115 billion from the prior month-end.
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 $56B in MBS and almost $84B in Treasuries, offset by “Other” dropping $26B
The “Other” category surged and fell last year due to Repurchase Agreements. This is the opposite of the Reverse Repos shown in the Money Supply article. In standard Repo Agreements, the Fed buys from a dealer with an agreement to return the security. This was designed to be temporary, providing unlimited liquidity to the Treasury market for governments or institutions that needed cash.
Regardless of the reason for using Repos, the maturing of “Other” gives the Fed cover to purchase above their target mandate of $80B Treasuries and $40B in MBS.
Figure: 1 Monthly Change by Instrument
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 $1.39T over the last year
- The Fed targeted bonds maturing in 1-5 years in the most recent month
- Even though 1 to 5-year is the largest holding bucket, 7-10 Maturity is almost half the size but saw nearly zero additions
- Perhaps this is one reason the 10-year rates were able to rise so much in September
- The spread between the 2 and 10-year widened from 1.11% on Sept 1 to 1.25% on Sept 29
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 activity is what led to the widening in spreads, that means the Fed is having a large impact on the Treasury market. This will spell trouble as tapering begins.
Figure: 2 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 13% and 6.4% to 11.6% respectively.
Figure: 3 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 $41B in MBS mature versus $98B purchased over the last two weeks. Looking at the chart shows a large drop of 1 to 5-year maturity in mid-August. Perhaps this is what drove the Fed to buy into this area of the yield curve with such a concentrated move this past week.
Figure: 4 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 $24.7B per week for 4 weeks which is less than the $27B and $26.7B over 24 and 52 weeks.
Figure: 5 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 to 10-year), 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. 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. This is slightly down over last month but mainly because the Treasury has been focused on letting Bills mature and issuing a higher amount of Notes and Bonds. This conversion of short to long term at the Treasury is occurring even while the total debt sits unchanged at the debt limit.
Regardless of the Treasury moving debt around, who is going to absorb all the 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: 6 Debt Issuance by Year and Instrument
Figure: 7 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 may accelerate rather than decelerate.
Figure: 8 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: Sep 29, 2021