Fed’s QT: Total assets drop $ 91 billion from peak (QE created money, QT destroys money)

What the Fed did in detail and charts.

By Wolf Richter for WOLF STREET.

The Federal Reserve’s quantitative tightening (QT) concluded the second month of the three-month transition period. Total assets in the Fed’s weekly balance sheet as of August 3, released this afternoon, fell by $ 17 billion from the previous week and $ 91 billion from the peak in April, to $ 8.87 trillion, the lowest level since February 2. .

QE created money that the Fed injected into the financial markets through its primary players, from where it began circulating and chasing assets, including in non-financial markets such as housing and commercial real estate. The purpose and effect were to suppress yields and create asset price inflation. And in the end it also helped to create a furious inflation of consumer prices.

QT does the opposite – it destroys money and has all the opposite effects, not for day traders but for the long term. QT is one of the tools the Fed is using to quell this now raging consumer price inflation.

Treasuries: -52 billion dollars from the peak.

July: -30 billion dollars in roll-offs + 4.6 billion dollars in TIPS inflation compensation.

Treasury bills and bonds come out in the middle of the month and at the end of the month, when they mature. Today’s budget includes the roll-off at the end of July.

Treasury Inflation-Protected Securities (TIPS) pay inflation compensation which is added to the principal value of the TIPS. When TIPS matures, holders receive the original nominal amount plus compensation for accumulated inflation that has been added to principal.

The Fed currently holds $ 374 billion in TIPS. The inflation compensation amount is about $ 1 billion to $ 1.5 billion per budget week, or about $ 4 billion to $ 5 billion per calendar month, which adds to the balance of Treasury securities.

The QT phased-in plan (June to August) calls for the Fed to allow $ 30 billion in Treasuries per calendar month as they mature. And the Fed did exactly that in July.

So why did Treasuries only fall by $ 25.2 billion and not the $ 30 billion that fell? INFLATION COMPENSATION TIPS!

  • The Fed left $ 30 billion in Treasury bonds without replacement, which reduced the balance of $ 30 billion.
  • The Fed received $ 4.6 billion in inflation compensation from the government, which increased the balance of $ 4.6 billion
  • Net effect: The total balance fell by $ 25.2 billion.

The inflation compensation is added to the balance of Treasury securities every week is why the balance reduction will be less each month than the actual roll-off.

In the chart below, note the steady increase of about $ 1-1.5 billion per week after the end of QE from mid-March to June 6, which is the inflation offset by TIPS.

The Treasury stock amount has now fallen by $ 52 billion from its June 6 peak to $ 5.72 trillion, the lowest since January 26:

MBS, the peculiar creatures with the great delay.

How MBS can get out of the budget:

  • Pass-through capital payments – the main way
  • When broadcasters “call” MBS
  • When MBS mature, they are usually “called” before they mature
  • When the Fed sells them, which they said could happen someday in the future.

Pass-through capital payment: When the underlying mortgages are paid off (due to a sale or refi of the property) or when regular mortgage installments are paid, the mortgage manager (the company to which the mortgage payments are sent) forwards the principal payments to the entity that securitized the mortgage into MBS (such as Fannie Mae), which then forwards those principal payments to MBS holders (such as the Fed).

The book value of the MBS is reduced with each pass-through principal payment. This reduces the amount of MBS on the Fed’s balance sheet. These key pass-through payments are erratic and unpredictable.

The broadcaster “calls” the MBS. After a good number of years of pass-through principal payments, the residual book value of the MBS may have decreased so much that the MBS is no longer worth serving and the issuer, like Fannie Mae, decides to “call back” the MBS MBS to repackage the residual mortgage debt into new MBS along with other mortgages. When Fannie Mae “calls” the MBS, they are off the Fed’s balance sheet.

When MBS mature. MBS have maturities of 15 or 30 years. But this is largely irrelevant because the average life of mortgages in the US is less than 10 years because they are paid off due to a sale or a refi. And when the residual book value of the MBS falls below a certain level, the issuer calls them back and takes them off the books.

How MBS enters the balance sheet.

The Fed bought MBS in the “To Be Announced” (TBA) market during QE, and to a lesser extent during the Taper, and to a minuscule extent in June and July. The June and July purchases are designed to replace the June and July main pass-through payments that exceeded the $ 17.5 billion monthly limit.

But purchases in the TBA market take one to three months to stabilize. The Fed records its trades after they are established.

So the inflow of MBS into the balance sheet in the last few weeks comes from operations carried out a few months ago, before QT. What we are seeing now are the purchases made during the Taper.

These purchases are not aligned with the main pass-through payments the Fed receives. This misalignment, and the three-month delay, creates the ups and downs of the MBS balance, which is also visible in the overall balance sheet.

MBS: $ -23 billion from peak to $ 2.72 trillion:

Non-amortized premiums: constantly decreasing.

All buyers pay a “premium” to buy bonds if the coupon interest rate of that bond exceeds the market yield at the time of purchase.

The Fed records securities at face value in checking accounts and records the “premiums” in a special account, the “unamortized premiums”. The Fed then amortizes the premium to zero over the bond’s residual life, while at the same time receiving the highest coupon interest. When the bond matures, the premium is fully amortized and the Fed receives the face value and the bond leaves the balance sheet.

“Unamortised premiums” peaked with the start of tapering in November 2021 at $ 356 billion and have now declined steadily from $ 26 billion to $ 330 billion:

The other QE and rescue activities have largely disappeared.

  • Special Purpose Vehicles (SPV) through which the Fed bought bonds, loans and ETFs: $ 38 billion
  • Central Bank Cash Swap: $ 0.2 billion.
  • Repo: $ 0

Money Printing Comes Home:

In the 15 years of this graph, there are three crises: the financial crisis, the pandemic and now the unleashed inflation. Today’s inflationary crisis goes in the opposite direction to the two previous crises and to tackle it will require the application of tools in the opposite direction:

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