New Round of QE with a Stated Different Purpose
By the Curmudgeon
To the surprise of no one (see ShadowStats Analysis below), the U.S. Federal Reserve will once again be buying vast amounts of government-backed fixed income securities which will further boost the size of its already-massive $4 trillion balance sheet. The Fed says that at least for now, the objective is to calm stress in financial markets, rather than a new round of monetary stimulus to boost the U.S. economy.
Heres a chart of the Feds Balance Sheet over the last 12 months:
(Source: Federal Reserve Board)
Caption: After hitting a peak of over $4.5T, the Feds balance sheet had been declining since October 2017, but has recently spiked upward to approach $4T.
The Fed announced on Friday it will launch a new program next week that will purchase $60 billion of Treasury bills per month (using money created out of thin air). It will then adjust both the timing and amounts of T-bill purchases as necessary to maintain an ample supply of reserve balances over time.
The buying will continue at least into the second quarter of 2020. New purchase amounts will be announced on the ninth business day of each month.
The U.S. central bank is trying to stabilize money markets after several turbulent weeks since interest rates for overnight repurchase agreements (repos) 1 essentially short-term loans between banks and other financial institutions spiked in September. The run-up spilled over into money markets, pushing the Fed Funds rate temporarily above the range that policymakers were targeting.
Note 1. In the repo market, borrowers seeking cash offer lenders collateral in the form of U.S. government securitiesfrequently Treasury bondsin exchange for a short-term loan. The term of these loans can be as short as overnight.
Many were surprised when the rate on repos surged in mid-September to well above the target range for short-term borrowing set by the Fed (the Fed Funds rate). Fed chairman Jerome Powell acknowledged that these markets experienced "unexpectedly intense volatility."
On Thursday, The New York Federal added $88.1 billion to the financial system, using the market for repos to relieve funding pressure in money markets. That type of buying has greatly increased the Feds Balance Sheet by $176 Billion from September 11 to 30, 2019 as per this graph:
(Source: Federal Reserve Board)
The most recent balance sheet expansion is due to the Fed making hundreds of billions of dollars a week in revolving loans to Wall Street securities firms (primary dealers) by intervening in the repo market.
The Fed will continue to intervene in the market for repos, something the New York Fed branch began to do last month as rates climbed. The Fed will keep those operations going at least through January of next year, according to the press release, to ensure that the supply of reserves remains ample even during periods of sharp increases in non-reserve liabilities.
Significance of the Feds Move:
While the amount could change, buying $60 billion in Treasury bills over a month is substantial, even by the Feds standards. For context, the Fed bought about $85 billion in bonds each month during its final round of quantitative easing, which started in 2012.
The Fed posted a Frequently Asked Questions press release on Friday that sought to draw a bright line between the moves and what happened during the crisis.
"These operations have no material implications for the stance of monetary policy," the statement said, adding that there should be "little if any effect" on household and business spending nor the overall level of economic activity.
Instead, the Fed just wants to make sure there is enough cash sloshing around the financial system, because lately there hasn't been. This volatility (in the repo market) can impede the effective implementation of monetary policy, and we are addressing it, Powell said.
Comments from Economists:
The size of the package surprised some onlookers, including Priya Misra, head of global rates strategy at TD Securities. This is building a buffer, and its doing it faster than I thought, Ms. Misra said.
Some onlookers were skeptical that the Fed would manage to convince investors that this was not an attempt to bolster the economy, given the size of the purchases.
When it swims like a duck and quacks like a duck, its hard to prove your intentions arent fowl, Paul Ashworth, chief economist at Capital Economics, wrote in research note.
They want to keep Q.E. as something special, said Laura Rosner, a co-founder of MacroPolicy Perspectives. I dont think they want to send a signal that things are bad.
The Fed is telling investors that their bond purchases do not stimulate the economy, yet they will probably need investors to believe that Fed bond buying will be stimulative if genuine QE is invoked during the next recession. I see some tensions there, Ms. Rosner said.
"You don't want to have funding shocks add to the worsening outlook. We don't need this problem on top of our other problems," said Ralph Axel, senior US rates strategist at Bank of America Merrill Lynch. "They are winging it, absolutely," Axel added.
UBS has warned that U.S. GDP growth will tumble to near-zero next year, forcing the Fed to slash interest rates by another percentage point between now and the first half of 2020. "We've got a pretty massive slowdown in our forecasts," said Rob Martin, US economist at UBS.
Mr. Williams was not surprised by Fridays Fed announcement. John wrote in his latest commentary (subscribers only):
Powell had suggested in an earlier October 8th speech that such a move was coming, but he emphasized ... that growth of our balance sheet for reserve management purposes should in no way be confused with the large-scale asset purchase programs [a.k.a. Quantitative Easing] that we deployed after the financial crisis.
The New York Fed effectively has been forced to provide QE in recent weeks, in order to maintain adequate overnight systemic liquidity, recently announcing continuing overnight funding through November 4th, post FOMC October 29-30, 2019 meeting.
Adding Liquidity to the System Tends to Boost the Economy, Irrespective of Intent.
Cash is fungible, and cash in the system tends to increase with added liquidity. Such tends to support and expand economic activity, irrespective of how much the FOMC would like the world to think that the U.S. economic activity is just fine and dandy. (Its not!)
Williams Recommendation to the Fed:
The ShadowStats broad economic outlook remains unchanged, other than as exacerbated by fast-moving and potentially extreme domestic and global political instabilities and other systemic stresses. A rapidly intensifying U.S. economic downturn is foreseen.
Accordingly, it is time now for the Fed to ease aggressively, not only cutting its targeted Federal Funds Rate by 0.50%, but also by re-expanding Quantitative Easing (QE) at the upcoming October 29th to 30th FOMC meeting.
Good luck and till next time
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Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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