Fed’s QT: Total Assets Down $139B from Peak

Sticks to Plan, QT Like Clockwork: My super-blue extra fun on what the Fed is doing in details and charts and the “To Be Announced” market for MBS.

by Wolf Richter for WOLF STREET.

The Federal Reserve’s quantitative easing (QT) ended its three-month cycle on August 31. At the time of the QT phase, the plan called for the Fed to allow its holdings of Treasury securities to decline to $30 billion each. by letting them pay without replacement and allowing their mortgage-backed securities (MBS) to fall to $17.5 billion a month, mostly due to principal payments.

In September, the QT rate nearly doubled to $60 billion per month for Treasuries and $35 billion for MBS. So how was the month of August?

Total assets of the Fed weekly balance sheet As of August 31, released on September 1, it fell $25 billion from the previous week, $48 billion from the balance on August 3 and $139 billion from the peak on April 13, to $8.83 trillion, the lowest since January 12. .

QE created money that the Fed injected into financial markets by buying securities from their primary dealers, who then sent that money into financial markets and other markets, including residential and commercial real estate, inflating asset prices. It lowered incomes and mortgage rates and other interest rates, the express purpose of QE.

And in early 2021, QE suddenly helped fuel rampant consumer price inflation that the Fed was poised to combat with, you guessed it, QT rate hikes.

QT has the opposite effect of QE: It destroys money, raises incomes, pulls the rug out from under active price inflation, and helps reverse consumer price inflation.

QT is direct with regular Treasury securities, complicated only by the Fed’s holdings of Treasury Inflation-Protected Securities (TIPS). But MBS is a different entity, as we shall see in a moment.

Treasuries: $76 billion down from peak.

Treasury notes and bonds are written off in the middle of the month and at the end of the month when they mature. Today’s balance sheet includes turnover as of August 31.

TIPS pay inflation compensation (income). But the coupon is not paid as interest. Instead, it is added to the principal value of the TIPS. When TIPS mature, holders receive the original face value plus accumulated inflation compensation added to the principal over the years (similar to your I-Bonds).

In August:

Treasury notes and bonds: down $30.4 billion.
TIPS Inflation Compensation: $6.0 billion increased, earned and added to TIPS principal.
Net change: -$24 billion from August 3 balance.

This inflation compensation, about $1.5 billion a week, is income earned by the Fed and paid out in cash by the Treasury Department. When TIPS matures. The Fed adds this yield to the weekly TIPS balance. You can see it on a slightly upward slope in the chart below, after QE ends in mid-March and before QT starts until June 6th.

MBS, live with big delay: $31 billion below peak.

We’re going to do some super, extra, unusual stuff today, WOLF STREET, we’re going to dive deep into the Fed’s dealings with MBS in the Announced (TBA) market, which I’ve uploaded to my server, and I’ll walk you through it in a program. moment. It will definitely be the most fun you’ll ever have. But before we get there…

MBS exit the balance sheet through principal payments. When principal mortgages are paid off due to the sale of a home or condo, or regular mortgage payments are made, the principal is transferred by the mortgage servicer (such as your bank) to the mortgage securitization entity (such as Fannie Mae), which forwards those principal payments to the MBS holders (such as the Fed).

The carrying amount of an MBS decreases with the passing of each principal payment. This reduces the amount of MBS on the Fed’s balance sheet. These key switch payments are uneven and unpredictable.

MBS come onto the balance sheet 1-3 months after the Fed purchases them in the To Be Announced (TBA) market.

And we will have fun with it now.

Purchases in the TBA market take one to three months to resolve. The Fed books its trades once they are settled.

I uploaded a spreadsheet I downloaded from the NY Fed containing a portion of the MBS trades in the TBA market onto the WOLF STREET server. I have color-coded the chart to make research easier (Download my “NYFed_MBS-ops” spreadsheet here).

The table shows how each MBS is included on the Fed’s balance sheet and how long the delinquency is for each MBS:

I marked in red: all MBS purchases settled in August (settlement date = Column J). They settled on August 11, 16 and 18.
The Fed’s weekly balance sheet is always on Wednesday and is released on Thursday.
- MBS settled on August 18th appeared on the balance sheet on August 24th, but they coincided with a large stack of transitional principal payments that outpaced ineffective purchases and reduced the balance that day.
- MBS settled on August 11th and 16th appeared on the August 17th balance sheet and you can see how the MBS balance went up.
Now go to column C (yellow) “Date of execution” when the MBS is bought in the TBA market.
I marked the MBS purchased in June in bold red (column C). And three months later, they appeared in the balance sheets of August-17 and August-24.
Now on to the Fed Bought in May, before QT, I marked in green (column C = purchase dates). There are a lot of them, $108 billion (I added them to column Y). Keep scrolling down to line 265 to see them all.
In column J (settlement dates), You see the MBS that the Fed bought before QT in May were placed during QT in June and July, is when they appear on the balance sheet. That’s why people thought the Fed didn’t QT.

Wasn’t that hilarious fun? I thought so!

The Fed is doing everything it says it will do; you just need to understand the mechanics of the TBA market and the balance sheet.

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

Unamortized premiums: down $29 billion from peak to $327 billion.

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

The Fed records the securities at par in regular accounts and records the “premiums” in an account it calls “unamortized premiums.” The Fed then amortizes each bond’s premium to zero over the bond’s remaining maturity. At the same time, it charges higher coupon interest payments. When the bond matures, the premium is fully amortized and the Fed receives the face value and the bond is off balance sheet.

“Unamortized premiums” reached $356 billion in November 2021 and are now down $29 billion to $327 billion in a steady process:

For your entertainment, here’s how we got to Raging Inflation:

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