The Fed’s Balance Sheet Shows Intent to Support Housing Forever

Mortgage-Backed Securities Duration Synopsis

• Total mortgage assets have risen from $1.422 trillion in December of 2019 to $2.628 trillion in December of 2021.
• Currently, 97.6% of the mortgages the Fed holds are 10 years or longer duration all the way up to 30 years. 

Let’s compare that balance sheet expansion with that of US treasuries. 

Duration of Fed’s Balance Sheet US Treasuries

Treasuries Duration Synopsis

• Total treasury assets have risen from $2.301 trillion in December of 2019 to $5.638 trillion in December of 2021.
• Currently, 23.9% of the treasuries the Fed holds are 10 years or longer duration.

What if the Fed let its balance sheet unwind for a full 10 years?

10-Year Natural Unwind

• After 10 years, 97.6% of the mortgages would still be on the Fed’s book. And if the duration of the existing mortgages was 30-year mortgages, then they would still be in the 10-year and older bucket.
• For comparison purposes, after 10 years, only 23.9% of the treasuries would still be on the Fed’s book. 

Chart Source

A reader asked where the data is from. The answer is straight from the Fed Archives.

I took data from the current report, a year ago, and two years ago.

Don’t Worry, the Fed has Belts and Suspenders

Does anyone recall Bernanke’s alleged plan to shrink the Fed’s balance sheet?

If not, I can help. 

Please recall my 2020 post regarding statements Bernanke made when he was still Fed Chair: Don’t Worry, the Fed has Belts and Suspenders

On February 27, 2013, Ben Bernanke spoke to US Congress about how the Fed would unwind its balance sheet.

Bernanke said, We Have “Belts, Suspenders” to Unwind Balance Sheet .

Bernanke’s vague answer to Sen. Richard Shelby, R-AL, when asked how the Fed will deleverage the balance sheet, was this: “In terms of exiting from our balance sheet… a couple of years ago we put out a plan; we have a set of tools. I think we have belts, suspenders – two pairs of suspenders. I think we have the technical means to unwind at the appropriate time; of course picking the exact moment to do, of course, is always difficult.”

What About the Current Divergence?

The Fed does not intend to ever do what Bernanke said he would do. It never did, and I said so in 2013 as well.

But what about the divergence between mortgages and treasuries?

I brought this up in a Tweet the other day in which I stated the Fed may try hard to prevent the yield curve from inverting. 

Take a peak at that Treasury balance sheet again. Even without adding to it its sheet, the Fed has plenty of room to micromanage things.

I suspect the Fed will make a statement about maintaining its balance sheet for “a while” if and when they actually finish tapering, 

Then the Fed will have lots of room to do things like buy more 3-year notes and sell 5-year notes (or vice versa, whatever the Fed seeks to accomplish) right from its balance sheet without having to resort to new operations.

The Fed might be able to pull off an Operation Twist move without even announcing it. In this kind of setup, the yield curve may go flat without strongly inverting. 

Mortgages vs Treasuries

While it’s true mortgages are long-term commitments, the Fed has no intention of winding them down or any portion of its balance sheet down.

Mortgage-backed securities will wind down when people refinance, but the bulk of that has been done. Only if rates hit new record lows will there be much of a mortgage wind down and not even then if the Fed maintains the size of its balance sheet.

Meanwhile, mortgage rates are are also heavily influenced by 10-year treasuries and there is ample room for the Fed while holding its balance sheet constant to manipulate 10-year treasuries.  

We will learn the Fed’s true intent if and when it makes a statement about maintaining the size of its balance sheet for “a while” which I propose will be permanent.

What About Recession?

I believe one is coming much faster than anyone at the Fed believes. Heck another set of lockdowns could do it, anything actually. 

All it will take is an investor attitude shift on the stock market. The stock market adds buoyancy to all kinds of spending. 

Given the increased ability of the Fed to micromanage the yield curve without starting new programs, don’t think we will necessarily have huge inversions across the curve as has happened in previous recessions.

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