The Fed has shed 31% of the Treasury securities it had added during pandemic QE.
By Wolf Richter for WOLF STREET.
The Fed’s Quantitative Tightening (QT) hums along on autopilot. But the banks have figured out since one-year yields began to drop last November that they can earn risk-free interest income by borrowing from the Fed at the lower rate of the bank bailout facility, the BTFP, of around 4.85%, and then deposit that cash back at the Fed as reserves and earn 5.4%, risk free, hassle-free, thank you.
That cash stays at the Fed, it doesn’t go anywhere, it just makes the banks some risk-free moolah. And use of that trick has jumped, obviously. That facility is set to expire in March, so they’re trying to get in while they still can. And we’ll get to that in a moment.
Total assets on the Fed’s balance sheet dropped by $56 billion in December, to $7.68 trillion, the lowest since March 2021, according to the Fed’s weekly balance sheet today. Since peak-QE in April 2022, the Fed has shed $1.284 trillion. The closeup view:
During QT #1 between November 2017 and August 2019, the Fed’s total assets dropped by $688 billion, while inflation was below or at the Fed’s target (1.8% core PCE in August 2019), and the Fed was just trying to “normalize” its balance sheet.
Now inflation is still ricocheting through services, with “core services CPI” running at an annualized rate of 5.8%, though overall inflation rates were brought down by plunging energy prices and dropping durable goods prices.
QT hums along on autopilot.
Treasury securities: -$59.5 billion in December, -$1.02 trillion from peak in June 2022, to $4.75 trillion, the lowest since January 2021.
The Fed has shed 31.1% of the $3.27 trillion in Treasury securities that it had added during its pandemic QE.
Treasury notes (2- to 10-year securities) and bonds (20- & 30-year securities) “roll off” the balance sheet mid-month and at the end of the month when they mature and the Fed gets paid face value. The roll-off is capped at $60 billion per month, and about that much has been rolling off, minus the inflation protection the Fed earns on Treasury Inflation Protected Securities (TIPS) which is added to the principal of the TIPS.
The special function of Treasury bills for the pace of QT. These short-term securities (1 month to 1 year) are included in the $4.75 trillion of Treasury securities on the Fed’s balance sheet. But they have an important function for the pace of QT.
The Fed lets them roll off (doesn’t replace them when they mature) if not enough longer-term Treasury securities mature and roll off to get to the $60-billion monthly cap. As long as the Fed has T-bills, the roll-off of Treasury securities will reach the cap of $60 billion every month.
When the Fed runs out of T-bills to fill in the gaps, the Treasury roll-off will start to fall below the $60 billion cap.
From March 2020 through the ramp-up of QT, the Fed held $326 billion in T-bills that it constantly replaced as they matured (the flat line in the chart). In September 2022, T-bills first started rolling off as needed to get the Treasury roll offs to $60 billion a month.
T-bills are now down to $217 billion, after $14 billion rolled off in December.
The Fed’s diminishing weight in the Treasury market: 17.6%
The incredibly ballooning US national debt, at $34 trillion, comes in two kinds of Treasury securities:
$26.9 trillion of Treasury securities are traded and held by investors, including by the Fed. These “marketable securities” make up the Treasury bond market.
$7.1 trillion of Treasury securities are held by entities of the US government, such as by government pension funds and the Social Security Trust Fund and are not in the bond market.
The Fed has now shed $1.02 trillion of Treasury securities, and its share of the “marketable” Treasury securities” — aka “Debt held by the public” — has fallen to 17.6%, from over 24% at the peak, as QT has reduced the Treasury securities on the Fed’s balance sheet, and as government debt ballooned (data points are quarterly).
Mortgage-Backed Securities (MBS): -$15 billion in December, -$308 billion from the peak, to $2.43 trillion, the lowest since August 2021. The Fed has now shed 22% of the MBS it had added during pandemic QE.
The Fed only holds government-backed MBS, and taxpayers carry the credit risk. MBS come off the balance sheet primarily via pass-through principal payments that holders receive when mortgages are paid off (mortgaged homes are sold, mortgages are refinanced) and when mortgage payments are made.
The higher mortgage rates have caused home sales to plunge and mortgage refinancings to collapse, which slowed the mortgage payoffs, and therefore the pass-through principal payments. The MBS run-off has been between $15 billion and $21 billion a month, far below the $35-billion cap.
Banks got an arbitrage opportunity when yields dropped.
Discount Window: $2.2 billion. Roughly in this range for months, and down from $153 billion in bank-panic March (red line in the chart below). The Discount Window is the Fed’s classic liquidity supply to banks. The Fed currently charges banks 5.5%, and demands collateral at market value, and that’s expensive money for banks.
Bank Term Funding Program (BTFP): OK, now here comes the cheaper money. To borrow at the BTFP, banks have to pay the Fed a rate equal to the one-year overnight index swap rate plus 10 basis points, fixed for the term of the loan, up to one year. Back in March 2023, when the BTFP was invented, that rate worked out to be a little lower than the rate at the Discount Window, and collateral requirements were looser. So banks used it.
But starting in November, Treasury yields and related yields began to drop on rate-cut expectations. At the end of October, the 1-year Treasury yield was still at around 5.4%. The one-year overnight index swap rate was a little lower. By mid-December, the one-year yield had dropped to 4.9%, by the end of December, to 4.8%. The BTFP was charging banks around 4.85%, encouraging them to borrow at 4.85% from the Fed and deposit this cash back at the Fed in their reserve account to earn 5.4%, making them a risk-free spread of over 50 basis points.
It seems, however, that the Fed is looking askance at this trade, and only smaller banks are into it, not JP Morgan with $1 trillion.
The BTFP balance rose by $20 billion in December to $141 billion. This is the blue line in the chart below; note the surge starting in November. The BTFP is set to expire in March, so they’re trying to get in while they still can (the Discount Window is the red line):
The other bank bailout measures.
Repos: $0. Repos with “foreign official” counterparties (likely the Swiss National Bank which was backstopping the take-under of Credit Suisse by UBS) were paid off in April. The repos with US counterparties faded out in July 2020 and have remained at around zero. The Fed currently charges counterparties 5.5% on repos, as part of its five policy rates.
Loans to FDIC: $0. The FDIC paid off the remainder in November.
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