Fed balance sheet drops $289 billion from peak: November update on quantitative tightening

We are also keeping an eye on primary credit and examining the Fed’s agreement with the Swiss National Bank.

By Wolf Richter for WOLF STREET.

Total Federal Reserve Assets weekly reviewreleased today, with balances as of November 2, fell $82 billion from the October 5 balance sheet to $8.68 trillion, the lowest since December 8, 2021.

Treasury securities mature in the middle of the month and at the end of the month, that is, when they come off the Fed’s balance sheet. Today’s weekly report included the Treasury roll-off on October 31st.

Treasuries: Down $196 billion from the peak.

Since the peak in early June, $196 billion of Treasury securities have moved off the Fed’s balance sheet, reducing the Treasury securities balance to $5.57 billion, the lowest since Nov. 17.

In the four weeks since the October 5 tally, $59 billion has been spent:

  • Treasury bills and bonds (2-30 years): -$46.2 billion
  • Treasury bills (1 year or less): -$12.6 billion
  • Treasury Inflation Protected Securities (TIPS): unchanged
  • TIPS inflation compensation: -$0.07 billion

Mortgage-backed securities: down $62 billion from the peak.

Since the peak, the MBS balance had fallen by $62 billion. Over the past four weeks, the balance has shrunk by $20 billion.

MBS exit the balance sheet primarily through principal payments that occur when the underlying mortgage is paid off or when regular mortgage payments are made. Mortgages are paid off primarily when the house is sold or when the mortgage is refinanced. Since mortgage interest rates soared, refinancing activity has collapsed (read: The woes of mortgage lenders), and mortgage payments on the sale of the house plunged home sales are down 30% from two years ago. Thus, transmitted principal payments have gone from a torrent in 2021 to a stream now.

The influx of new MBS on the balance sheet dried up in October after the Fed stopped buying MBS in mid-September.

Back when the Fed was still buying large amounts of MBS and there was still a torrent of principal payments, the weekly shift in timing between the two created the jagged line in the chart. Since the large inflows ended, there is no further upside. Downticks represent passed-on principal payments:

Unamortized premiums: down $36 billion from peak.

Like everyone who buys bonds in the secondary market, the Fed had to pay a “premium” on face value when it bought securities that had been issued years earlier when interest rates were higher. and therefore came with a higher coupon interest rate than the market yield at the time of purchase.

The Fed books the face value of securities in the regular accounts and it books the “premiums” in an account called “unamortized premiums”. It amortizes the premium of each bond to zero over the remaining term of the bond. When the bond matures, the Fed receives the face value of the bond and it comes off the balance sheet. At that time, the premium has already been fully amortized.

Unamortized premiums fell $36 billion from the November 2021 peak to $320 billion:

The to-do on the Swiss National Bank.

In October, there was catastrophic chatter in some corners of the blogosphere about the Fed suddenly and “quietly” handing over a gazillion dollars to the Swiss National Bank.

In fact, the Fed and the Swiss National Bank conducted dollar liquidity swaps on the Fed’s swap line with the SNB which has been operational for many years. It was 7 day swaps, and after 7 days the Fed gets its dollars back.

In total, they performed five consecutive 7-day swaps, starting on September 14. The last and largest swap, for $11.1 billion, matured on October 27. Since then, there has been no swap with the SNB, and the balance with the SNB is now $0.

This graph shows the use of swap lines during times of high financial friction. That little dot at the end is the SNB:

Keep an eye on “Primary Credit.”

The Fed lends money to banks and charges interest on these loans. Yesterday, as part of its rate hikes, the Fed raised the primary lending rate by 75 basis points points to 4.0%, which it now charges banks when they borrow from the “discount window”.

In March 2020, primary credit balances reached $50 billion. During the financial crisis, primary credit soared to $110 billion. Both faded quickly and then remained at very low levels.

When the Fed started raising rates in early 2022, primary credit started to rise slightly. At the peak in early October, primary credit stood at $7.5 billion. On today’s balance sheet, it’s down to $4.4 billion. So that’s something we’re going to keep an eye on.

QT is the opposite of QE.

With QE, the Fed created money and with it bought securities through its primary traders in the financial markets, and that money then started chasing assets, which inflated asset prices and drove down yields, mortgage rates and other interest rates.

QT works in the opposite direction and does the opposite and is part of the explicit tools the Fed is using to quell this runaway inflation that was partly the result of years of QE. But for years, QE didn’t trigger consumer price inflation – it just triggered asset price inflation, giving all central banks plenty of opportunities to learn all the wrong lessons. Until it suddenly triggered massive consumer price inflation. And now we have this huge mess.

And how we got to Raging Inflation:

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Carol N. Valencia