QE creates money. QT does the opposite: it destroys money.
By Wolf Richter for WOLF STREET.
Total Assets on Fed Weekly balance sheet as of July 6, released this afternoon, fell $22 billion from the previous week and $74 billion from the April high to $8.89 trillion, the lowest since the February 9, as the Fed’s quantitative tightening (QT) began. The zigzag pattern is due to the special nature of mortgage-backed securities (MBS) which we will discuss in a moment.
Treasuries fell $20 billion for the week and $27 billion from the peak.
Outings: twice a month. Treasuries and bonds mature in the middle and at the end of the month, that is, when they leave the Fed’s balance sheet, which in June was June 15 and June 30.
Tightening deniers. Last week’s tally was as of June 29 and did not include the June 30 run-off. However, the army of crunch deniers who troll the internet and social media don’t know this, and so a week ago they rolled out and announced that the Fed had already terminated QT, or was backtracking , because the Treasuries hadn’t fallen in two weeks, which was hilarious. Or more sinister: hedge funds manipulating the markets through their henchmen?
TIPS inflation compensation adds to the balance. Inflation-protected Treasury securities pay an inflation offset that is added to the face value of TIPS (similar to popular “I bonds”). So, if you hold a fixed number of TIPS, their nominal value will increase with the amount of inflation compensation. When they mature, you will receive the full amount of the original face value plus inflation compensation.
The Fed holds $384 billion worth of TIPS at their original face value. He received $92 billion in inflation compensation on these TIPS. This inflation offset increased its holdings of TIPS to $476 billion.
During the month of June, inflation compensation increased by $4 billion. In other words, until these TIPS mature and disappear from the balance sheet, the Fed holdings of TIPS will increase by the amount of inflation compensation – currently around $1-1.5 billion per week!
No TIPS expired in June. But next week, on July 15, TIPS with an initial face value of $9.6 billion plus $2.5 billion of inflation compensation will mature, for a total of $12.1 billion. dollars, which the Fed will receive. After that, the next TIPS maturity on the Fed balance sheet is January 15, 2023. And the TIPS balance will increase from July 15 to January 15 due to inflation compensation.
The thing to remember about Fed TIPS is that the inflation offset is added to the TIPS balance and therefore the Treasury securities balance, at around $1-1.5 billion per week currently.
The Treasury securities balance fell $20 billion from the previous week and $27 billion from the June 8 peak, to $5.74 trillion, the lowest since February 23:
- Note the two runoffs on the balance sheets on June 16 and today.
- Note the small steady increase of around $1-1.5 billion per week after the end of QE from mid-March to June, which is the TIPS inflation offset.
MBS fell $31 billion from the peak.
Direct Principal Payments. MBS holders receive principal payments passed on when the underlying mortgages are paid off after the sale of the house or the refinancing of the mortgage, and when the mortgage payments are made. As a principal payment is made, the MBS balance decreases by that amount. These direct principal payments are irregular and unpredictable.
Purchases on the TBA market and deferred settlement. During QE, and to a much lesser extent during tapering, and to a tiny extent now, the Fed tries to keep the MBS balance from contracting too quickly by buying MBS in the “To Be Announced” market (TBA ). But purchases on the TBA market take one to three months to settle. The Fed books its transactions after they have been settled. Thus, the purchases included in any balance sheet were made one to three months earlier.
This lag is why it takes months for the MBS balance to reflect current Fed buying. The purchases that we can see on the balance sheet in June were made around March and April.
And those purchases are not aligned with the passed-on principal payments the Fed receives. This misalignment creates ups and downs in the MBS balance, which also affect the overall balance sheet.
In addition, MBS can also be called by the issuer (like Fannie Mae) when the principal balance has declined so much that it is not worth maintaining the MBS (the issuer then reconditions the remaining underlying mortgages in new MBS).
Tightening deniers. So when crunch deniers – including a type of hedge fund with a huge following on Twitter – trolled the internet and social media that QT wasn’t happening because the MBS balance had grown by 1.2 billion dollars on the June 23 balance sheet, they got tangled in their own underwear. The following week, the MBS balance fell by $19.5 billion. This is how MBS work on the Fed’s balance sheet. These people simply didn’t know, or more insidiously tried to manipulate the markets.
The thing to remember about the Fed’s MBS balance is that it decreases because of principal payments passed on, and sometimes because they’re called, and it’s an uneven process.
The Fed’s holdings of MBS fell $31 billion from the peak.
The upward moves in the balance come from buying in the TBA market during the post-QE and pre-QT phase, when the Fed was trying to keep MBS balances flat. He has since reduced those purchases to small amounts, but they won’t show up for a few months. When they appear, the upward movements will be much smaller and will eventually disappear, and only the downward movement will continue, and the overall balance will drop faster:
Unamortized premiums decreased.
Unamortized premiums represent the amount the Fed paid in “premiums” over face value when it purchased Treasuries, MBS, and agency securities in the market.
Bond buyers, including me and the Fed, have to pay a premium to buy securities if the coupon interest rate exceeds the market yield at the time of purchase.
But unlike me, the Fed books securities at face value and records premiums in a separate account on its balance sheet. This adds some transparency. The Fed amortizes the premium to zero over the life of the bond, against the higher coupon interest payments. By the time the bond matures, the premium has been fully amortized, the Fed receives its face value, and the bond leaves the balance sheet.
Unamortized premiums peaked with the start of the phase-down in November 2021 at $356 billion and have now declined by $23 billion to $333 billion:
SPV creatures have almost disappeared.
The Fed set up Special Purpose Vehicles (SPVs) during the crisis to do QE with assets it was otherwise not allowed to buy. Equity financing was provided by the Treasury Department. The Fed has lent to SPVs and shows these loans plus Treasury Department equity financing in these SPV accounts.
Four of the eight SPVs have been completely unwound to date, and their balance is nil.
PPP loans the Fed purchased from banks fell to $18 billion and account for about half of total SPVs. The rest: Main Street Lending Program ($12 billion), Municipal Liquidity Facility ($7 billion) and TALF ($2 billion). The primary credit account (less than $2 billion) is also listed. For a total of $39 billion, compared to $208 billion in July 2020.
QE creates money. QT does the opposite: it destroys money.
With EQthe Fed creates money which it then injects into the financial markets via its primary dealers, and this money is used to buy assets, and as this money chases assets, it inflates the prices of assets of all kinds, which which means it lowers long-term interest rates, including mortgage rates, which further inflates house prices, etc. This is the official reason for the deployment of QE.
With QT, the Fed is doing the opposite. QT inverse QE. QT destroys some of the money that QE had created, with the opposite effect on yields and asset prices, and house prices, etc., pushing up long-term interest rates and deflating asset prices.
The Fed is now tightening policies – raising rates and launching the QT – because inflation has soared to its highest level in 40 years, spread across the economy and deep into services , and becomes firmly anchored. This inflation is partly the result of QE. And QT is one of the tools the Fed uses to fight inflation.
Fed assets from crisis to crisis – money printing comes home:
In the 15 years of this graph, there are two crises: the financial crisis and now the inflation crisis. Today’s inflation crisis is going in the opposite direction to the financial crisis, and dealing with it will require opposite tools:
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