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The Fed Lied. It Could Never Meet Its QT Targets as Announced

On May 4, the Fed released its plan achieve balance sheet reduction of $60 billion a month in Treasuries and $35 billion a month in MBS. The latter is fake.
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Fed's balance sheet courtesy of the New York Fed, chart by Mish

Fed's balance sheet courtesy of the New York Fed, chart by Mish

Announced Plan is Bogus

The chart above shows the Fed's announced plan is bogus. 

To understand why, please consider the Fed's Plans for Reducing the Size of the Federal Reserve's Balance Sheet, emphasis mine

  1. The Committee intends to reduce the Federal Reserve's securities holdings over time in a predictable manner primarily by adjusting the amounts reinvested of principal payments received from securities held in the System Open Market Account (SOMA). Beginning on June 1, principal payments from securities held in the SOMA will be reinvested to the extent that they exceed monthly caps.
  2. For Treasury securities, the cap will initially be set at $30 billion per month and after three months will increase to $60 billion per month. The decline in holdings of Treasury securities under this monthly cap will include Treasury coupon securities and, to the extent that coupon maturities are less than the monthly cap, Treasury bills.
  3. For agency debt and agency mortgage-backed securities, the cap will initially be set at $17.5 billion per month and after three months will increase to $35 billion per month.
  4. Over time, the Committee intends to maintain securities holdings in amounts needed to implement monetary policy efficiently and effectively in its ample reserves regime.
  5. To ensure a smooth transition, the Committee intends to slow and then stop the decline in the size of the balance sheet when reserve balances are somewhat above the level it judges to be consistent with ample reserves.

Point 3 is the problem. 

The Fed announced a natural runoff. That is, the Fed will not reinvest interest or principal payments or securities that have reached maturities. Nor will the Fed resort to outright sales from its balance sheet.

Duration Mismatch 

Check out the duration of Treasuries and MBS in my lead chart. There is room for Treasury runoffs.

But as of May 12, MBS looks like this.

Fed's MBS Balance Sheet Holdings

  • Within 15 Days: $0
  • 16-90 days: $1 Million
  • 91 days to 1 year: $53 Million
  • Over 1 year to 5 Years: 2.1 Billion
  • Over 5 Years to 10 Years: $62.6 Billion
  • Over 10 Years $2.65 Trillion

Nature of the Lie

Q: How is the Fed going to do $350 billion a year in MBS reduction when there will be no refinance operations and a lousy $54 million in natural runoffs?
A: It won't and the Fed purposely put out a disingenuous proposal it knew it would never meet. Lie is a better description.

Backing Off the Announcement

New York Federal Reserve President John Williams tried to whitewash the Fed's lie on Monday. 

Reuters reported Sales of Fed's mortgage-backed securities may be future option

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Williams said MBS sales are not under consideration for the first stages of the plan unveiled this month to pare down the Fed's $9 trillion balance sheet starting in June. Speaking to a Mortgage Bankers Association conference, Williams said "once our balance sheet reduction is well underway ... that is an option that the Federal Open Market Committee (FOMC) could consider."

U.S. central bank officials are confident the $60 billion monthly cap they have established for redemptions of Treasury securities during the quantitative tightening process should be achievable on a consistent basis. But Williams said the $35 billion monthly target for MBS redemptions may prove harder to reach each month.

"That's a pretty big number," Williams said. "Our own forecasts are that we wouldn't see $35" billion every month especially now that the jump in interest rates on mortgages has dramatically slowed refinancing activity.

Hoot of the Day

"Our own forecasts are that we wouldn't see $35" billion every month." 

What a hoot. Will it achieve $35 billion in any month?

I called the Fed out the moment it announced the plan on May 4. I used the Fed's own data in the lead chart to spotlight the inherent lie in their announcement.

Clearly the Fed is very concerned about QT of MBS despite their repeated statements they should not be holding mortgages. 

Genuine Free Money, Fed Style, Goes Straight to Banks

In case you missed it, also consider Genuine Free Money, Fed Style, Goes Straight to Banks

This post originated at MishTalk.Com.


A reader points out that the Fed may come close to MBS targets by run-downs,

In almost all instances mortgages pay off well before maturity and since they are amortizing they are paying off a bit of principal every month (so a mortgage that actually did go the distance would have a tiny piece of principal remaining to be repaid with the final payment).

Two things are relevant here in determining the amount of principal repayment the fed is receiving each month and whether that number exceeds the cap (17.5 for june-august, 35 after that) or if not by how much it undershoots it: The monthly prepayment speeds on the MBS and The aggregate principal paid down as part of normal amortization on the mortgages.

For the aggregate principal paid down as part of normal amortization assuming 2.7 trillion UPB on a blended duration of 27 years at 3.35% (no idea if this is correct but seems reasonable enough) you'd expect ~5 billion a month in normal principal prepayment. 

This combined 32 billion is reasonably close the the feds announced ( 34.5 billion repurchase of MBS from may 13 - june 13 prior to the caps kicking in. 

That said, it is definitely reasonable to expect prepayment speeds to drop somewhat from the April number since those prepayments mostly reflect rate locks (for either refi or paired purchase transaction for a borrower changing houses) in the mid February to mid March timeframe when prevailing rates were a bit lower than now. How low will that CPR go when the prepayments reflect rate lock periods at current rates? Its a good question. Personally, I think halving the rate to 6 is the lowest extreme we would reach, which still means 14-15 billion a month in prepayment in addition to 5-6 billion in regular principal paydown. 

In sum, the Fed should easily be able to rundown the 17.5 billion over the next 3 months. Beyond that Its probably more reasonable to expect between 20-30 billion a month runoff, so below the 35 cap for sure (honestly they could not reach the 35 cap right now based on the announced 34.5 billion repurchase)

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