Fed Balance Sheet Shrink: Big Problem Or Non-Event?

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Includes: BIL, DFVL, DFVS, DLBL, DLBS, DTUL, DTUS, DTYL, DTYS, EDV, EGF, FIBR, FTT, GBIL, GOVT, GSY, HYDD, IEF, IEI, ITE, PLW, PST, RISE, SCHO, SCHR, SHV, SHY, SPTL, SPTS, TAPR, TBF, TBT, TBX, TBZ, TLH, TLT, TMF, TMV, TTT, TUZ, TYBS, TYD, TYNS, TYO, UBT, UST, VGIT, VGLT, VGSH, VUSTX, ZROZ
by: Bill Kort

I’d like to begin this post with something I wrote on June 17, 2013 (“The Dreaded Taper”).

The Fed is buying $85.0 billion of intermediate to longer-term treasury securities and agency MBS per month, about $4.0 billion per day split evenly between the two classes. Meanwhile the Treasury is issuing $40.0 to $45.0 billion per month in new debt. Ergo, it can be said that the Fed is buying everything that Treasury is selling at a rate of $2.0 billion per day. However, there is an active market in U.S. Treasury securities averaging trading volume over $500 billion per day (you may find a current chart on Treasury market trading volume below). As to the agency MBS part of the equation, that market trades over $250 billion per day on average. The $2 billion going into this sector, again, is less than 1% of total volume. Against the backdrop of both markets $4 billion QE per day seems rather paltry.

Said another way, QE at $4 billion per day represents little more than 1/2 of 1 percent of incremental demand for longer-term government and agency MBS securities. It sounds like a big number, but in the context of a nearly $22 trillion combined market value and $750 billion combined daily combined trading volume, it is not.

If QE is withdrawn at the same pace that it was applied it will represent little more than half of one percent of incremental supply to the daily trade. This would seem to be the impending disaster that we will be faced with. To be sure rates will rise, and for all the right reasons, a stronger economy and a lessening of the fear that would lead an individual or institution to accept a 1.6% on a ten year note to get absolute guaranteed safety.

I was right about everything above except the last part (interest rates rising). It seems that lower rates in many of the developed economies in Europe and Asia have made our treasuries magnetic for foreign investment. This, coupled with many investors still fearful of stocks after their ‘horror show’ experience in 2008, has continued to keep our rates depressed. The rate on our 10-year TSY ended June of 2013 at 2.48%. Last Friday April 7, that rate was 2.38%. Whoda Thunk It?

Freaking out already!

Quantitative Easing (Q.E.) is a fertile field for the media

The reason that I bring this up is that four years ago the media created a major freak-out over Q.E., its creation and eventual tapering. I suspect that now that the Fed has raised the issue of its removal the hype will begin again. As an example, Randall Forsyth devoted half of his “Up and Down Wall Street” column to the issue this week. (You need a Barron’s or Wall Street Journal subscription to access).

Here’s another ditty from CNBC earlier in the week: “Why mortgages, other interest rates could go up faster than you think.”

This does not mean that the market won’t go down on any Fed move to reel in Q.E. … most people don’t read my work. It does mean, based on past experience, that it will probably not be the end of the world and may even create an opportunity. Consider this post a preemptive strike on the silliness.

What’s your take?

Average Daily Trading Volumes (billions)

U.S. Treasury1
Average Daily Trading Volume
USD Billions
Treasury Bills
Treasury Inflation Index Securities
Floating Rate Notes
Coupon Securities Due in 3 Years or Less
Coupon Securities Due in More Than 3 Years but Less Than or Equal to 6 Years
Coupon Securities Due in More Than 6 Years but Less Than or Equal to 11 Years
Coupon Securities Due in More Than 11 Years
Total2
2002 43.5 2.4 131.3 96.8 79.2 19.3 372.6
2003 43.4 3.6 137.7 122.7 98.7 24.2 430.3
2004 51.0 6.0 170.5 134.7 111.0 24.6 497.8
2005 51.0 8.9 191.9 141.6 126.1 29.4 549.0
2006 33.2 7.8 200.8 122.8 116.9 28.0 509.6
2007 45.7 8.2 209.5 145.0 127.1 30.5 566.0
2008 75.4 8.2 182.8 151.1 111.4 28.7 557.5
2009 76.1 5.2 136.1 82.6 87.2 23.9 411.1
2010 76.8 6.4 163.2 111.2 134.5 31.8 523.9
2011 72.8 9.5 177.7 135.1 137.1 35.7 567.8
2012 77.9 10.9 146.7 118.8 131.7 34.4 520.3
2013 81.1 12.4 146.6 129.7 140.1 35.4 545.4
2014 65.3 11.4 152.3 125.8 117.7 31.6 504.2
2015 65.0 12.8 2.0 134.0 120.4 115.9 39.9 490.1
2016 84.9 15.4 3.2 132.6 121.6 118.2 38.3 514.2
2015
Jan 64.5 14.7 1.6 132.3 125.5 128.0 46.9 513.4
Feb 58.7 14.4 1.7 146.7 137.9 143.9 54.3 557.5
Mar 64.2 14.7 2.3 157.2 127.3 118.5 40.4 524.5
Apr 64.6 12.2 1.5 122.6 105.3 96.6 30.7 433.6
May 59.0 13.2 1.2 132.5 116.8 134.9 45.9 503.5
Jun 59.7 12.2 2.7 137.3 127.6 127.5 39.4 506.5
Jul 59.8 12.1 1.4 120.9 116.8 110.8 41.1 463.1
Aug 67.4 13.6 1.9 129.6 122.9 126.2 47.7 509.3
Sep 67.8 12.9 2.2 142.6 121.6 116.0 35.9 498.9
Oct 53.4 12.1 1.9 114.8 117.2 98.0 38.7 436.2
Nov 73.0 11.6 3.2 151.8 142.9 118.8 36.8 538.0
Dec 84.0 11.1 3.0 125.6 94.5 85.2 27.3 430.7
2016
Jan 87.3 14.4 5.2 154.6 123.1 119.8 37.0 541.5
Feb 80.7 16.7 3.8 137.5 139.1 150.6 45.3 573.8
Mar 88.7 16.3 2.4 124.4 121.6 115.2 33.4 501.9
Apr 67.7 15.4 3.6 116.4 114.2 95.1 31.5 443.9
May 70.0 17.0 4.1 118.7 109.6 113.6 37.0 470.0
Jun 84.5 13.5 3.0 132.9 118.8 123.6 38.3 514.7
Jul 80.8 12.7 3.6 127.1 111.3 110.3 40.8 486.6
Aug 80.8 14.7 3.1 129.8 109.7 110.5 38.4 487.1
Sep 88.2 14.2 1.8 132.4 112.4 112.1 38.0 499.0
Oct 95.1 14.7 2.9 147.1 120.7 100.7 33.8 515.0
Nov 100.6 18.5 2.6 143.0 161.8 159.3 50.6 636.4
Dec 90.8 17.0 2.2 127.6 110.6 98.5 33.0 479.6
2017
Jan 91.5 18.8 4.3 135.2 137.9 114.2 35.6 537.4
Feb 90.0 23.9 3.5 141.5 131.2 118.6 39.9 548.7
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
2016 YTD 87.3 15.6 4.5 146.1 131.1 135.2 41.2 557.7
2017 YTD 91.5 21.4 3.9 138.3 134.5 116.4 37.8 543.0
% Change 4.8% 30.2% -17.9% -12.6% 12.0% -4.6%

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