Qualitative tightening continues, albeit at a slower pace.
Total assets on the Fed balance sheet declined by $43 billion in December, to $6.85 trillion, the lowest since May 2020, according to the Fed weekly balance sheet.
In theory, asset prices tend to decline when the Fed reduces its balance sheet, buying fewer assets.
“There is a positive correlation between the magnitude of the Fed balance sheet and the direction of financial asset prices.
QT, the reduction of the Fed balance sheet has more of a direct impact on financial asset prices than the changes to the Fed fund rates.
Changes to the Fed fund rates have a greater policy time lag than changes to the Fed balance sheet, withdrawal of liquidity has a real-time impact on financial assets,” Darren Winters wrote in a piece entitled, “Quantitative Tightening,” dated July 2023.
“There is a positive correlation between the magnitude of the Fed balance sheet and the direction of financial asset prices”
DARREN WINTERS
Despite the Fed QT stock indexes have held up
Last year, 2024 the Fed held its base rates in the restrictive territory and continued with its ongoing QT.
In December total QT amounted to -$2.11 Trillion from the peak $8.85 Trillion of Fed total assets on its balance sheet in mid-2022, which means the Fed balance sheet ended the year at $6.85 Trillion.
During the relatively good times, in other words, no economic or financial crisis or pandemic lockdowns, from say 2015, to 2019 the Fed balance sheet totalled on average $4.3 Trillion.
Pre-2008 subprime financial crisis and the great recession which followed the Fed’s balance sheet was under $1 Trillion.
Then, from crisis to crisis, the first one being the 2008 financial crisis, the Fed balance sheet doubled to $2 Trillion in 2009 and progressively increased with quantitative easing QE, QE2, QE3 and other versions of QE Operation Twist. QE, the purchase of assets by the Fed, propelled the Fed balance sheet to over $4 Trillion in 2014 and it stayed there until 2020.
“During the relatively good times, in other words, no economic or financial crisis or pandemic lockdowns, from say 2015, to 2019 the Fed balance sheet totalled on average $4.3 Trillion”
WIN INVESTING
The next crisis, the 2020 pandemic global lockdowns, the Fed balance sheet took a moonshot.
Public-funded pandemic relief led the Fed to restart its bond-buying programme QE, sending the Fed balance sheet to nearly $9 Trillion in 2022.
In just two years the Fed’s balance sheet more than doubled by $5 trillion to its peak of $8.85 Trillion in 2022.
Qualitative tightening continues at a cautiously slow pace
QT kicked off in 2023 with a rocky ride.
The worst treasury bond market in history played out in 2023, sending treasury yields sharply higher in a short duration.
Moreover, the returns of treasury Bills, with maturity under one year, were far higher than bank cash deposit accounts.
So rational savers pulled their money from low-paying interest on bank deposits and bought treasury bills with more favourable yields.
Capital flows out of banks into treasury bills were the catalyst for the 2023 banking liquidity crisis, with at least six known regional banks declaring bankruptcy that year.
“Regarding the $3.27 trillion in Treasuries piled on the balance sheet during pandemic QE, the Fed has now shed 45% of those assets” – Win Investing
Despite the 2023 banking liquidity crisis, the Fed’s quantitative tightening continued in 2024
So out of the total $ 2.1 Trillion in December, what assets has the Fed cut from its balance sheet?
Treasury securities: -$24.5 billion in December, -$1.48 trillion from peak, in June 2022, or -26% since the peak, to $4.29 trillion, the lowest since July 2020.
Regarding the $3.27 trillion in Treasuries piled on the balance sheet during pandemic QE, the Fed has now shed 45% of those assets.
Treasury notes (2- to 10-year) and Treasury bonds (20- & 30-year) roll off the balance sheet mid-month and at the end of the month when they mature and the Fed gets paid face value.
Since June, the roll-off has been capped at $25 billion per month, about that much rolled off in December, minus the amount of inflation protection the Fed earns on its Treasury Inflation Protected Securities (TIPS)
When the Fed holds a bond to maturity, the Fed gets paid cash for its face value, plus the remaining interest.
So the bond ceases to exist and the cash is withdrawn from circulation and the Fed balance sheet declines, which is the definition of roll-off.
If the Fed decided not to purchase new bonds with the cash received from the mature bonds, its balance sheet would decline more quickly. In other words, the Fed would take more money out of circulation, and the pace of QT would be faster.
“If the economy is robust, why have eight banks failed in two years since the Fed tightening?” – Win Investing
Despite the national debt increasing since 2022, Fed quantitative tightening continues
The Fed’s Treasury holdings of $4.29 trillion amount to 14.9% of the debt held by the public, the lowest since Q4 2019.
Moreover, despite home sales in 2024 plunging to their lowest level since 1995, Fed quantitative tightening continues with Mortgage-Backed Securities (MBS).
The Fed cut MBS by -$15.7 billion in November, -$507 billion from the peak, to $2.23 trillion, the lowest since May 2021.
The Fed has shed 18.5% of its peak holdings in April 2022.
In conclusion, qualitative tightening continues despite soaring public debts and depressed housing sales
The Fed appears to watch ideally as treasury bond yields rise, pushing interest payment on the Public Debt at now over $1 Trillion, the third largest budget item, according to the US Debt Clock.
Real estate sales are already in a slump at two-decade lows.
Two banks failed in 2024, First Bank & Trust Co. on October 18 and Fulton Bank, National Association on April 26.
In 2023, six banks failed.
If the economy is robust, why have eight banks failed in two years since the Fed tightening?
Qualitative tightening continues, but how many more banks could fail in 2025 until the Fed decides to ease?
Here is the anomaly, the Fed Discount Window, which is the Fed’s classic liquidity supply to banks at favourable rates of just 4.5% on loans plus collateral at market rate is expensive money for distressed banks. Demand for these loans fell to $3.2 billion in December. During the Bank panic in 2023, loans spiked to $153 billion.
Bank liquidity crisis no longer, or maybe worse, are these discount rates unaffordable for a new wave of distressed banks?
