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Fed’s balance sheet chart by Mish

I created the above sheet from the Federal Reserve report on Credit and Liquidity Programs and the Balance Sheet

The Fed says it will unwind its balance sheet, namely US Treasuries and Mortgage-Backed Securities (MBS).

First, here’s a look at what else the Fed is holding now.

Fed’s Balance Sheet Details

Fed’s balance sheet details chart by Mish

The Fed expanded QE aggressively for years. But nearly all the expansion was longer-dated securities as the following chart shows.

Fed’s Balance Sheet by Duration 

Fed’s balance sheet details chart by Mish

If the Fed had short-term securities, it could reduce its balance sheet simply by runoff. 

Instead, the Fed will aggressively have to sell securities, especially MBS, if it really wants to reduce its balance sheet as quickly as it has implied.

This is with housing and the economy already slowing.

How High Will 30-Year Mortgage Rates Go in 2022?

Earlier today, I asked How High Will 30-Year Mortgage Rates Go in 2022?

Mortgage rates are strongly correlated to the 10-year treasury yield. Other factors include Mortgage Rate Convexity, QT, and hedge funds front-running QT. See the above link for discussion.

If the Fed does aggressive balance sheet reduction, including mortgages, we are likely to see a sustained jump in mortgage rates even if the yield on 10-year notes levels off. 

Tomorrow the Fed will outline some of the QT parameters. Let’s see what they say, But the more aggressive they claim, the more skeptical I will be.

Not the Only Skeptic 

Soft Landing Window Closed

As you can see, I’m not the only one who thinks the Fed will talk a much bigger game than they play.

Anything Else?

Yes.

Rate hikes are a very blunt instrument for fixing inflation problems.

Much depends on how fast the Fed can cause a recession, destroy demand, and crush the stock market and housing too.

Expect More Pain

If you think earnings and the stock market will rise with this going on, I’ve got news for you: Expect More Stock Market Pain Because It’s Coming

And If You Think I’m Bearish Please Read John Hussman

Feelin’ Lucky?

This post originated at MishTalk.Com.

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Mike Shedlock

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38 Comments
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Jackula
Jackula
4 years ago
Interesting! Can we say stagflation is now on deck?
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KidHorn
KidHorn
4 years ago
The FED is doing the exact opposite of the BOJ. The BOJ is doing everything possible to keep a lid on interest rates. I think the BOJ may have decided they’re going to get out of their debt hole via currency devaluation.
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Nuddernoitall
Nuddernoitall
4 years ago
Accuracy is important to me, so I may have to post a correction to my earlier comment about a highly probable 75 basis point Fed hike in June. Here was the exact quote I read this afternoon…. “A 50 basis point rate hike from the FOMC on Wednesday is fully priced in to the fed funds futures market, according to the CME’s FedWatch Tool. What matters more at this juncture, though, is that the fed funds futures market is assigning a 95.7% probability to a 75 basis point rate hike at the June 14-15 FOMC meeting.” My problem is, when I go to CME’s FedWatch Tool, I’m not seeing (or understanding) the data properly. Does this mean that the Fed is assuredly raising the Fed Rate 75 basis points, or that the futures market overshoots par and factors in rate hikes generally not expected to occur?
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Christoball
Christoball
4 years ago
Reply to  Nuddernoitall
That is a good question.
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Mish
Mish
4 years ago
Reply to  Christoball
Those CME odds reflect how futures speculators and hedgers bet. They also reflect Fed statements and a bit of frontrunning perceived opinions of the Fed.
50 basis points on Wednesday is assured. I believe that’s all we see in June.
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Nuddernoitall
Nuddernoitall
4 years ago
Reply to  Mish
Thanks for your clarification, Mish. I agree that Wednesday’s hike of 50 seems locked in and also the June 50 bp hike seems to be “most” everyone’s guess (currently). I would not have been so mystified if the June futures market priced a 75 basis point increase at 35% or 40% or even 50% …. but 95.7%? Seems counter to me, but maybe that’s just how the speculators and hedgers play. Thanks again.
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jcom
jcom
4 years ago
“Instead, the Fed will aggressively have to sell securities, especially MBS, if it really wants to reduce its balance sheet as quickly as it has implied.”
This is not correct. The MBS figures you present in the Fed’s Balance Sheet By Duration are the aggregate Unpaid Principal Balance of the Feds MBS Holdings.
Each month that number is reduced by the aggregate principal portion of all those borrowers monthly mortgage payments + any prepayments (which while slowing will continue at some level due to ill advised cash out refinances or borrowers moving and selling their currently mortgaged home). Over the last 3 months that has roughly been 40 billion a month which the fed has been replacing with new purchases of MBS (see https://www.newyorkfed.org/markets/ambs/ambs_schedule).
So effectively the Fed has ~ 40 billion a month of natural MBS runoff and that figure should grow by 1-2 billion a month as the Feds MBS gets later into its amortization schedule. This exceeds the 35 billion the fed previously indicated would be the max monthly runoff. So expect the Fed to remain a buyer of MBS, albeit much less of one.
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Cocoa
Cocoa
4 years ago
So, who buys this bad debt. UST, OK maybe. MBS????? If the FED is a consortium of member banks, the most logical buyer is trying to sell.
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KidHorn
KidHorn
4 years ago
Reply to  Cocoa
I don’t think the FED is going to be selling much. I think the bulk of their reduction is going to be letting things roll off.
But if they were, there are many holders of MBS outside of the FED. They would simply buy more and probably get a pretty good discount. After all the FED doesn’t care if they make a profit. That’s the primary reason the markets stay elevated. The biggest buyer isn’t trying to make a profit. They actually try to lose money in many instances.
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RonJ
RonJ
4 years ago
“Rate hikes are a very blunt instrument for fixing inflation problems.”
Doesn’t the FED know that the cure for higher prices, is higher prices?

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Six000mileyear
Six000mileyear
4 years ago
With the FED holding MBS, they are the defacto “bad bank” even before the next wave of foreclosures takes place. And it’s not like the FED Reserve can buy insurance because they are the last line of defense.
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Captain Ahab
Captain Ahab
4 years ago
Reply to  Six000mileyear
Go the next step. Who takes the hit when the Fed’s long duration bonds and MBS, acquired at say 2%, sell at a yield of say 5%?
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Lisa_Hooker
Lisa_Hooker
4 years ago
Reply to  Captain Ahab
All together now — WE DO!!!
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Siliconguy
Siliconguy
4 years ago
Reply to  Six000mileyear
Do they even care if a MBS defaults? If I owned a MBS that defaulted I would care because I need that income to pay the bills. If the Fed owns it, it’s a bookkeeping entry. They don’t need the income to pay the bills, they don’t need to sell it and realize the losses.
A defaulted bond or MBS is deflationary in principle, but deflation would be fine just now, and again, would the impact ever leave the Fed?
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Sunriver
Sunriver
4 years ago
Certainly the long dated $90 billion monthly ‘roll off’ will indeed raise interest rates at the long end. Heck the roll off will affect the short term also. The FED’s $9 trillion ‘Piggy Bank’ was a disaster waiting to happen, and indeed let’s be honest, if the FED gets to say a $7 trillion ‘Piggy Bank’ balance, once the economy collapses, the FED will change course. There is no way out and that is the sad part of all of this. Either we will get an inflationary recession (depression) or a deflationary recession (depression). Pick your poison, but I believe the FED will attempt the inflationary route.
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Cocoa
Cocoa
4 years ago
Reply to  Sunriver
No matter what, you get the Minsky moment-where revenue can’t pay debt interest. So guess what, taxes will go up a gizzillion percent. So they do that, stave off deflationary depression for a bit until the taxpayers revolt.
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Lisa_Hooker
Lisa_Hooker
4 years ago
Reply to  Cocoa
Followed by a depressionary reflation.
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Bam_Man
Bam_Man
4 years ago
The Fed is not going to be selling ANYTHING.
They will stop purchases and just not replace maturing securities on their Balance Sheet.
That will be the extent of the “QT” and it will take many, many years to significantly reduce the size of their Balance Sheet.
This will be particularly true with regard to the MBS they hold, now that home sales are slowing and refinancings are virtually nil.
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Sunriver
Sunriver
4 years ago
Reply to  Bam_Man
I certainly would not be purchasing MBS(s). The FED will take a huge loss in their balance sheet reduction which may last just a few months.
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Bam_Man
Bam_Man
4 years ago
Reply to  Sunriver
They will not have to realize any losses because they will NOT be selling anything.
Securities held to maturity to not get marked-to-market.
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Captain Ahab
Captain Ahab
4 years ago
Reply to  Bam_Man
Which means the massive loss does not show up, but it is still there.
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Bam_Man
Bam_Man
4 years ago
Reply to  Captain Ahab
They have a digital printing press to deal with that.
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shamrock
shamrock
4 years ago
Reply to  Bam_Man
That’s a very long shot prediction, considering they have already indicated they will be selling, and selling substantially, and not just letting bonds go to maturity without rolling over.
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KidHorn
KidHorn
4 years ago
Reply to  Bam_Man
I think they hold close to a trillion of securities maturing in the next 12 months. If they let things mature and not roll over, their balance sheet will shrink pretty fast.
You can do the math from this…
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MPO45
MPO45
4 years ago
We have started the transition from “goods” to “services” and it starts with Lyft and AirBnB posting results.
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PapaDave
PapaDave
4 years ago
Reply to  MPO45
Sorry. I was paying attention to BP and MEG results.
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MPO45
MPO45
4 years ago
Reply to  PapaDave
bp did very well despite $25 billion Russia hit. i hope they raise dividend back to the good old days.
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PapaDave
PapaDave
4 years ago
Reply to  MPO45
I expect most oil and commodity companies to raise dividends and/or share buybacks in order to distribute their large free cash flows (after reducing their debt to target levels).
Low debt levels are an advantage if the economy goes into a recession. And allows companies to maintain base dividends when others cannot.
And if there is no recession, then even more FCF goes back to shareholders.
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Christoball
Christoball
4 years ago
Reply to  PapaDave
Cash buybacks are often just buying back stock incentives that executives are remitting at a rate that would cause share prices to drop without the buybacks.
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PapaDave
PapaDave
4 years ago
Reply to  Christoball
That may be true in many cases. However, most of the companies I am looking at, have received approval to repurchase 10% to 20% of their stock over the next 12 months, while executive compensation, in terms of stock incentives, is tiny in comparison.
As free cash flow expands, these companies are targeting debt first. Once debt reaches target levels, then share buybacks and/or dividend increases begin. For example, CVE has now reached debt levels that commit the company to return 50% of FCF to shareholders. Once the next debt level is reached, the company has committed to return 100% of FCF. These types of commitments to shareholders are becoming common.
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shamrock
shamrock
4 years ago
So much doom, and more than a little gloom, lol. Not sure how big an issue this is but haven’t those long bonds dropped 20% in value? They are sitting on massive losses. I wonder how they account for losses in money created out of thin air.
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hmk
hmk
4 years ago
Reply to  shamrock
I think the intrest they collect on their remaining portfolio will go to cover the principle loss on those sales. Normally the interest would be paid back to the Treasury.
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Bam_Man
Bam_Man
4 years ago
Reply to  shamrock
That is why they will not be selling ANYTHING.
Securities held to maturity do NOT have to be marked-to-market.
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Nuddernoitall
Nuddernoitall
4 years ago
“the fed funds futures market is assigning a 95.7% probability to a 75 basis point rate hike at the June 14-15 FOMC meeting.” Whoa …I did not see that coming.
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Nuddernoitall
Nuddernoitall
4 years ago
Reply to  Nuddernoitall
Source is CME’s FedWatch Tool
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Tony Bennett
Tony Bennett
4 years ago
Balance sheet
Put me down for $15 trillion before it breaks below $8 trillion.
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Bam_Man
Bam_Man
4 years ago
Reply to  Tony Bennett
You are right because they will not be selling ANYTHING, so it will take many years to reduce the size of the balance sheet meaningfully via maturing securities. The MBS will take forever to amortize now that home sales have slowed and re-fi’s have completely dried up.
We are likely to see them resume “emergency” QE before the balance sheet gets as low as $8 trillion.
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Cocoa
Cocoa
4 years ago
Reply to  Bam_Man
The FED is still buying, just slowing purchases. I expect that balance sheet to keep moving up. If they STOPPED? Thats not going to happen
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