Fed’s QT: Total wealth down $91 billion from peak (QE created money, QT destroys money) – WOLF STREET | Gmx Pharm

What the Fed did in details and charts.

By Wolf Richter for WOLF STREET.

The Federal Reserve’s quantitative tightening (QT) ended its second month of the three-month introductory phase. Total assets in the Fed’s Aug. 3 weekly balance sheet, released this afternoon, are down $17 billion from the previous week and down $91 billion from April’s peak to $8.87 trillion , the lowest level since February 2.

QE created money that the Fed pumped into financial markets through its primary dealers, from where it began circulating and hounding assets, including in non-financial markets such as residential and commercial real estate. The purpose and effect was to depress yields and create asset price inflation. And it eventually helped generate rampant consumer price inflation, too.

QT does the opposite: it destroys money and has all the opposite effects – not for day traders, but over the longer term. QT is one of the tools the Fed is using to combat this now raging consumer price inflation.

Treasuries: -$52bn from peak.

July: -$30 billion roll-off + $4.6 billion in TIPS inflation compensation.

Treasury bills and bonds are paid mid-month and at the end of the month when they mature. Today’s balance includes the roll-off at the end of July.

Treasury Inflation-Protected Securities (TIPS) pay inflation compensation that is added to the capital value of the TIPS. When the TIPS mature, holders will receive the amount of the original face value plus the cumulative inflationary allowance added to the principal.

The Fed currently holds $374 billion in TIPS. The amount of inflation adjustment is about $1 to $1.5 billion per balance sheet week, or about $4 to $5 billion per calendar month adds to the government bond balance.

The QT phase-in plan (June-August) sees the Fed maturing $30 billion of Treasuries per calendar month as they mature. And that’s exactly what the Fed did in July.

So why did Treasuries only fall $25.2 billion and not $30 billion? TIPS Inflation Compensation!

  • The Fed rolled off $30 billion worth of government bonds without replacement, what reduced the rest by $30 billion.
  • The Fed received $4.6 billion in inflation compensation from the government elevated the rest by $4.6 billion
  • Net Effect: The total balance decreased by $25.2 billion.

Inflation adjustment is added to the stock of government bonds everyone week is why the balance reduction each month is less than the actual roll-off.

In the chart below, note the steady increase of around $1-1.5 billion per week after QE ended from mid-March to June 6, which is in line with TIPS’ inflation compensation.

The amount of government bonds has fallen by $52 billion to $5.72 trillion since the June 6 peak, its lowest level since January 26:

MBS, the peculiar creatures with great lag.

How MBS can come from the balance sheet:

  • Pass-through capital payments – the primary route
  • When issuers “call” MBS.
  • However, when MBS mature, they are usually “called” before they mature
  • If the Fed sells them, which they say they might someday in the future.

Pass-Through Main Payments: When the underlying mortgages are paid off (due to a sale or refication of the property) or when regular mortgage payments are made, the mortgage servicer (the company you send the mortgage payments to) passes the principal payments on to the company securitizing the mortgage has mortgages in MBS (like Fannie Mae), which then passes those principal payments on to the holders of the MBS (like the Fed).

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

The issuer “calls” the MBS. After a good number of years of principal payments passed through, the remaining book value of the MBS may have fallen so low that it is no longer worth servicing the MBS and the issuer, like Fannie Mae, decides to “call” the MBS. MBS to repackage the remaining mortgage debt into new MBS along with other mortgages. If Fannie Mae “calls” the MBS, they will be taken off the Fed’s balance sheet.

When MBS mature. MBS have terms of 15 or 30 years. However, this is largely irrelevant as the average lifespan of mortgages in the US is less than 10 years as they are being paid off due to a sale or repayment. And when the residual book value of the MBS falls below a certain level, the issuer calls them and takes them off the books.

How MBS get into the balance sheet.

The Fed bought MBS on the To Be Announced (TBA) market during quantitative easing and to a lesser extent during the taper and to a tiny extent in June and July. The June and July purchases are expected to replace pass-through capital payments in June and July, which surpassed the $17.5 billion monthly cap.

However, it takes one to three months to process purchases in the TBA market. The Fed books its trades after they unwind.

So, the inflow of MBS into the balance sheet over the past few weeks comes from trades executed prior to QT a few months ago. What we are seeing now are the purchases made during the taper.

These purchases are not aligned with the pass-through capital payments that the Fed receives. This misalignment and the three-month lag create the ups and downs in the MBS balance sheet, which is then also reflected in the overall balance sheet.

MBS: -$23 billion from peak at $2.72 trillion:

Unamortized premiums: steady decline.

All buyers pay a “premium” to buy bonds if the coupon rate on that bond exceeds the market yield at the time of purchase.

The Fed books securities at face value in the regular accounts and books the “premiums” in a special account, “unamortized premiums.” The Fed then writes the premium down to zero over the remaining life of the bond while still receiving the higher coupon interest payments. When the bond matures, the premium is fully amortized, the Fed receives par value, and the bond is taken off the balance sheet.

“Unamortized premiums” peaked at $356 billion when the taper began in November 2021 and has now declined by $26 billion to $330 billion in a steady process:

The other QE and bailouts are largely gone.

  • Special Purpose Vehicles (SPVs) through which the Fed bought bonds, loans and ETFs: $38 billion
  • Central Bank Liquidity Swaps: $0.2 billion.
  • Repos: $0

The money printing comes home to settle:

There are three crises in the 15 years of this chart: the financial crisis, the pandemic, and now rampant inflation. Today’s inflationary crisis is moving in the opposite direction of the previous two crises, and tackling it requires applying the tools in the opposite direction:

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