Fed’s QT: Total Assets Drop by $139 Billion from Peak


It sticks to the plan, QT like clockwork: what the Fed did in details and charts, and my super-geek extra fun dive into the “To Be Announced” market for MBS.

By Wolf Richter for WOLF STREET.

The Federal Reserve’s quantitative tightening (QT) completed its three-month phasing-in period on August 31. During the phasing-in of QT, the plan called for the Fed to reduce its holdings of Treasury bills by up to $30 billion a year. by letting them mature without replacement, and dropping its mortgage-backed securities (MBS) by up to $17.5 billion per month, primarily through pass-through principal payments.

In September, QT pace roughly doubles with caps doubling to $60 billion per month for Treasuries and to $35 billion for MBS. How was it in August?

Total assets on the Fed’s August 31 weekly balance sheet, published Sept. 1, declined $25 billion from the previous week, down $48 billion from the August 3 balance sheet and $139 billion from its peak on Aug. April 13 to $8.83 trillion, the lowest level since January 12.

QE created money that the Fed pumped into the financial markets by buying securities from its primary dealers, who then channeled this money into assets in the financial and other markets, including residential and commercial real estate, all of which pushed asset prices up, and drove yields and mortgage and other interest rates down, which was the express purpose of QE.

And in early 2021, QE suddenly helped fuel the furious consumer price inflation that the Fed has now begun to fight with rate hikes and, you guessed it, QT.

QT has the opposite effect of QE: it destroys money, drives up yields, removes the carpet from asset price inflation, and helps curb consumer price inflation.

QT is straight forward with regular Treasury bills, complicated only by the Fed’s holdings of Treasury Inflation Protected Securities (TIPS). But MBS is a different creature, as we’ll see in a moment.

Treasury bills: $76 billion below the peak.

Treasury bills and bonds are amortized mid-month and at the end of the month when they mature. Today’s balance sheet includes the roll-off on August 31.

TIPS pay inflation compensation (income). But it is not paid out like coupon interest. Instead, it is added to the main value of the TIPS. When TIPS expire, holders receive the amount of the original face value plus the accumulated inflation compensation added to the principal over the years (similar to your I bonds).

In August:

  • Treasury bills and bonds: $30.4 billion lower.
  • TIPS Inflation Offset: $6.0 billion up, earned and added to TIPS principal.
  • Net change: -$24 billion as of August 3rd balance sheet.

This inflation offset of about $1.5 billion a week is income that the Fed earns and will be paid in cash by the Treasury Department when the TIPS expires. The Fed adds these earnings to the TIPS balance on a weekly basis. You can see it in the chart below from the slight upward slope in the period after QE ended in mid-March and through June 6, before QT started.

MBS, creatures with a long lag: $31 billion below the peak.

We’re going to do some super extra special geeky stuff today, a WOLF STREET deep dive into the Fed’s trades from MBS in the To Be Announced (TBA) market that I’ve uploaded to my server and that I’ll walk you through in a moment. Without a doubt, this will be the most fun you’ve ever had. But before we get there…

MBS usually comes off the balance through pass-through principal payments. When the underlying mortgages are paid off due to a home sale or refinancing, or when regular mortgage payments are made, the principal is forwarded by the mortgage lender (such as your bank) to the entity that securitized the mortgages (such as Fannie Mae), which then forwards these principal payments to the holders of the MBS (such as the Fed).

The book value of the MBS shrinks with each passing on of the principal. This reduces the amount of MBS on the Fed’s balance sheet. These pass-through principal payments are uneven and unpredictable.

MBS come 1-3 months after the Fed bought them on the balance sheet in the “To Be Announced” (TBA) market.

And now we’re going to have a lot of fun with that.

Purchases in the TBA market take one to three months. The Fed posts its trades after they settle.

I have uploaded to the WOLF STREET server the spreadsheet I downloaded from the NY Fed showing some of its MBS business in the TBA market. To make the walk-through easier to follow, I’ve color-coded the spreadsheet (download my “NYFed_MBS-ops” spreadsheet here).

The spreadsheet shows how each of the MBS ends up in the Fed’s balance sheet and how long the delay is for each MBS:

  1. I marked red: all MBS purchases settled in August (settlement date = column J). They settled on August 11, August 16 and August 18.
  2. The Fed’s weekly balance sheet is always on Wednesday and is released on Thursday.
    • MBS settling on August 18 appeared on the August 24 balance sheet, but they coincided with a large pile of revolving principal payments that eventually overpowered the meager purchases and reduced the balance on that day.
    • The MBS settled on August 11 and 16 appeared on the August 17 balance sheet and you can see how the MBS balance rose.
  3. Now go to column C (yellow) “Date of Operation”, when the MBS were bought on the TBA market.
  4. I marked the MBS bought in June in bold red (column C). And they appeared on the balance sheets of August 17 and August 24 three months later.
  5. Now go to what the Fed bought in May, before QT, which I marked in green (column C = purchase dates). There are many, $108 billion (I added them up in column Y). Keep scrolling all the way down to line 265 to see them all.
  6. In column J (settlement dates), you see the MBS that the Fed bought in May, before QT, settled in June and July, during QT., when they appeared on the balance sheet. That’s why people thought the Fed wasn’t doing QT.

Wasn’t this hilarious fun? I thought so!

The Fed is doing exactly everything it said it would do; you just need to understand the mechanics of the TBA market and its balance.

MBS: $31 billion down from peak to $2.71 trillion:

Premiums not amortized: $29 billion down from peak to $327 billion.

All bond buyers pay a “premium” over the face value when they buy bonds when that bond’s coupon rate is higher than the market yield at the time of purchase for that term.

The Fed books securities at face value in its regular accounts and posts the “premiums” in an account it calls “unamortized premiums.” The Fed then writes off each bond’s premium to zero over the bond’s remaining life. At the same time, it receives the higher coupon interest payments. By the time the bond matures, the premium is fully amortized and the Fed receives its face value and the bond is off the balance sheet.

The “unamortized premiums” peaked at $356 billion in November 2021 and have now steadily declined by $29 billion to $327 billion:

For your entertainment, how we got to Raging Inflation:

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The Valley Voicehttp://thevalleyvoice.org
Christopher Brito is a social media producer and trending writer for The Valley Voice, with a focus on sports and stories related to race and culture.

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