It sticks to the plan, QT like clockwork: What the Fed has done with details and charts, and my super nerdy extra fun dives into MBS’s “to be announced” market.
Written by Wolf Richter for WOLF STREET.
The Federal Reserve’s Quantitative Tightening (QT) completed its three-month phase-in period on August 31st. During the QT phase-in, the plan would have required the Fed to reduce its holdings of Treasuries by up to $30 billion at a time. Allows its mortgage-backed securities (MBS) to mature without redemption and lose up to $17.5 billion each month.
In September, the pace of QT will almost double, and the US Treasury cap will double to $60 billion per month for US Treasuries and $35 billion for MBS. Well, how was August?
Total assets in the Fed’s weekly balance sheet as of Aug. 31, released Sept. 1, were up $25 billion from the previous week, $48 billion from the Aug. 3 balance sheet, and up from Apr. 13. $139 billion less than the day’s peak. $8.83 trillion, lowest since Jan. 12.
QE creates funds that the Fed puts into the financial markets by purchasing securities from primary dealers, who then track assets in financial markets and other markets (including residential and commercial real estate). all of which pushed up asset prices. It lowered yields and mortgage rates and other interest rates, which are the explicit objectives of quantitative easing.
And in early 2021, QE suddenly fueled rampant consumer price inflation as the Fed began to hike rates and fight QT.
QT has the opposite effect of QE. In other words, it helps destroy money, boost yields, moderate asset price inflation, and reduce consumer price inflation.
QT is straightforward with regular Treasury bills, but the only complication is that the Fed holds Treasury Inflation Protection Securities (TIPS). But MBS is a different organism, as we’ll see later.
Treasuries: $76bn down from peak.
Treasuries and bonds roll off mid-month and at the end of the month when they mature. Today’s balance sheet includes the August 31st roll-off.
TIPS pays inflation compensation (income). However, it is not paid like coupon interest. Instead, it is added to the TIPS principal value. When the TIPS matures, the holder receives the original face value plus cumulative inflation compensation added to the principal over the years (similar to an I-Bond).
- Treasuries and Treasuries: down $30.4 billion.
- TIPS Inflation Compensation: $6 billion increased, earned and added to TIPS principal.
- Net change: -$24 billion from the 3 August balance sheet.
This weekly inflation compensation of about $1.5 billion is Fed-earned income and will be paid in cash by the Treasury when the TIPS expire. The Federal Reserve adds this income to your TIPS balance each week. In the chart below, we can see that after QE ended his mid-March, he trended slightly upward in the period to June 6, before QT started.
MBS, the laggy critter: $31 billion down from peak.
Today we are going to do some very special nerdy things. WOLF STREET details his MBS Federal Reserve trades on the scheduled (TBA) market which he has uploaded to his server. for a moment. This is without a doubt the most fun you will ever have. But before we get there…
MBS moves off the balance sheet primarily through pass-through principal paymentsIf the sale or refinancing of the home has paid off the underlying mortgage or made regular mortgage payments, the principal portion is transferred to the mortgage by the mortgage servicer (such as a bank). transferred to the securitized entity (such as a bank). Fannie Mae) forwards these principal payments to MBS holders (such as the Fed).
The carrying value of MBS will be reduced with each pass-through principal payment. This reduces the amount of his MBS on the Fed’s balance sheet. These pass-through principal payments are uneven and unpredictable.
MBS will hit the balance sheet one to three months after the Fed buys them in the “to be announced” (TBA) market.
And that’s what I’m looking forward to now.
Purchases on the TBA Market take 1-3 months to settle. The Federal Reserve reserves the trade after it is settled.
I have uploaded to the WOLF STREET server a spreadsheet containing some MBS operations in the TBA market, downloaded from the NY Fed. To make the walkthrough easier, I’ve color coded the spreadsheet (download the spreadsheet “NYFed_MBS-ops” here).
The spreadsheet shows how each MBS is flowing to the Fed’s balance sheet and how long each MBS lags.
- I’ve marked in red: All MBS purchases that settled in August (settlement date = column J). They settled on August 11th, August 16th and August 18th.
- The Fed’s weekly balance sheet is always as of Wednesday and released on Thursday.
- The MBS that settled on August 18th appeared on the balance sheet on August 24th, but they were matched by a large number of pass-through principal payments that eventually overwhelmed the few purchases and left the day’s I have reduced my balance.
- The MBS settled on August 11th and 16th will show up on the balance sheet on August 17th, showing how the MBS balance has increased.
- Then go to Column C (yellow), ‘Working days’ when the MBS was purchased on the TBA market.
- MBS purchased in June are marked in bold red (column C). And they appeared on his balance sheet three months later, on August 17th and on August 24th.
- Now go to the Federal Reserve Board Purchased in May before QT, marked in green (column C = purchase date). There are a lot of them, $108 billion (I’ve added them to column Y). Scroll down to line 265 to see everything.
- In column J (settlement date), We can see that the MBS purchased by the Fed in May before the QT were settled in June and July during the QT., when it appears on the balance sheet. This is why people thought the Fed didn’t do QT.
Wasn’t this ridiculously fun? I thought so!
The Federal Reserve is doing exactly everything it said it would do. You need to understand how the TBA market and balance sheet work.
MBS: $2.71 trillion, down $31 billion from peak:
Unamortized premiums: $327 billion, down $29 billion from peak.
All bond buyers pay a “premium” above face value when buying a bond if the bond’s coupon rate is higher than the market yield at the time of purchase at its maturity.
The Federal Reserve books securities at face value in regular accounts and a “premium” in an account called the “unamortized premium.” The Fed then amortizes each bond’s premium to zero over the bond’s remaining maturity. At the same time, you receive higher coupon interest payments. By the time the bond matures, the premium has been fully amortized, the Fed has received the par value, and the bond is stripped from its balance sheet.
Unamortized premiums peaked at $356 billion in November 2021 and are now down $29 billion to $327 billion.
Enjoy how we got to Raging Inflation.
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