Fed's Balance Sheet, QE2 and Bond Purchase

Includes: DIA, IEF, SPY, TLT
by: Zhong Jin

It has been about a month since the Fed announced the QE2 program after the November FOMC meeting. In its statement following the meeting, it said:

The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month.

The following chart illustrates four-week growth rates for the T-note and T-bond holdings on the Fed’s balance sheet. The last time growth rates spiked was the beginning of QE1, when the FOMC decided to purchase "up to $300 billion of longer-term Treasury securities over the next six months," according to its March 18, 2009, statement.

(Click charts to enlarge)

For anyone who is interested in the QE2, the following table shows detail for securities held by Fed in the past five weeks. According to Federal Reserve’s balance sheet, the Fed increased its T-notes and T-bonds by $73.34 billion from Nov. 13 (2010) to Dec. 1. During this period, the Fed reduced its holding of MBS by $28.38 billion. The net increase for this four-week period is $44.96 billion, which is lower than the number implied in the November 2010 FOMC statement. Based on the statement, the Fed should have increased T-note and T-bond holdings by about $103.38 billion by Dec. 1, assuming the Fed reinvested any proceeds from the bond repayment in the same asset class.

To achieve its goal of buying $600 billion by June 2011, the Fed needs to raise the amount of its Treasury purchase in the next few months. Given the poor employment number for November, the Fed has strong incentives to do so. The steepness of the yield curve will become flatter. Prices of ETFs of long term bonds and equity index should benefit from this move.

Disclosure: No positions