Fed Launches
New Round of QE with a Stated Different Purpose
By the
Curmudgeon
Overview:
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.
Backgrounder:
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.
ShadowStats
John Williams Analysis:
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
The Curmudgeon
ajwdct@gmail.com
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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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