How Does Fed Reduce Balance Sheet?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
dodgy55
Posts: 4
Joined: Tue Jun 06, 2017 8:28 am

How Does Fed Reduce Balance Sheet?

Postby dodgy55 » Thu Jun 15, 2017 11:21 am

As a result of it's Quantitative Easing program the Federal Reserve has substantially increased it's balance sheet. Now the Federal Reserve is looking to reduce its balance sheet by a few trillion. Not sure if my current musing falls into this investment forum but for the life of me, I cannot figure out the Fed Reserve goes about reducing a balance sheet. To acquire the treasury bills for it's QE program it had to print bundles of $. A corporation can reduce a balance sheet by spinning off a division or incurring an operating loss. However, this does not apply to the Fed Reserve. I am sure there is a simple answer but just can't think of it. Can somebody explain to me how the Fed can reduce it's balance sheet?

jebmke
Posts: 6002
Joined: Thu Apr 05, 2007 2:44 pm

Re: How Does Fed Reduce Balance Sheet?

Postby jebmke » Thu Jun 15, 2017 11:26 am

From what I have heard, their plan is to allow securities that they hold to mature and reduce the level of repurchase. The intent is not to have significant sales of securities.
When you discover that you are riding a dead horse, the best strategy is to dismount.

Grt2bOutdoors
Posts: 16160
Joined: Thu Apr 05, 2007 8:20 pm
Location: New York

Re: How Does Fed Reduce Balance Sheet?

Postby Grt2bOutdoors » Thu Jun 15, 2017 11:27 am

Simple, as maturities of investments (bonds) are reached, the proceeds from issuer who is redeeming (cash) are not reinvested.
Excess cash not needed by the Federal Reserve is returned to the Treasury. The Treasury in turn may choose to issue less debt at various bond offering dates, thereby keeping within the authorized debt limit and also achieving the Fed's goal of reducing their balance sheet.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

User avatar
Phineas J. Whoopee
Posts: 6381
Joined: Sun Dec 18, 2011 6:18 pm

Re: How Does Fed Reduce Balance Sheet?

Postby Phineas J. Whoopee » Thu Jun 15, 2017 10:52 pm

If I may add a bit of detail, of course bonds mature. Mortgage-backed bonds do so gradually, because the homeowners pay back some principal along with interest every month.

After the Fed stopped its long-term bond buying program, it maintained the status quo by reinvesting matured capital. It's talking about gradually reducing its reinvestments, which over time will gradually reduce its assets and therefore its balance sheet.

The Fed is enabled, by Congress, to issue money. It bought the bonds by creating money to buy them. If it doesn't reinvest maturing capital, in effect it destroys the money it created.

The Fed makes quite a lot, because what it receives in interest on the bonds it owns even in normal times is much more than what it spends. It pays the profits directly to the US Treasury.

The Fed will reduce its balance sheet by choosing not to reinvest maturing funds. It also has the option to sell the bonds on the open market, but nobody is seriously talking about that yet, and it may never come up.

PJW

User avatar
Oicuryy
Posts: 1104
Joined: Thu Feb 22, 2007 10:29 pm

Re: How Does Fed Reduce Balance Sheet?

Postby Oicuryy » Fri Jun 16, 2017 12:21 am

When the Fed redeems a maturing bond that bond is removed from the asset side of its balance sheet. The Fed then uncreates the money it received from the maturing bond. That money became a liability of the Fed when the Fed created it. Uncreating it removes it from the liability side of the balance sheet.

Ron
Money is fungible | Abbreviations and Acronyms

Valuethinker
Posts: 31762
Joined: Fri May 11, 2007 11:07 am

Re: How Does Fed Reduce Balance Sheet?

Postby Valuethinker » Fri Jun 16, 2017 6:29 am

dodgy55 wrote:As a result of it's Quantitative Easing program the Federal Reserve has substantially increased it's balance sheet. Now the Federal Reserve is looking to reduce its balance sheet by a few trillion. Not sure if my current musing falls into this investment forum but for the life of me, I cannot figure out the Fed Reserve goes about reducing a balance sheet. To acquire the treasury bills for it's QE program it had to print bundles of $. A corporation can reduce a balance sheet by spinning off a division or incurring an operating loss. However, this does not apply to the Fed Reserve. I am sure there is a simple answer but just can't think of it. Can somebody explain to me how the Fed can reduce it's balance sheet?


As per others, by letting the securities mature (get repaid by the issuer) and then not "rolling" that money into new bonds.

I am sure it is published somewhere, but my guess is the duration of the QE portfolio would be around 8-9 years. So, roughly speaking, 1/9th expires every year.

The size is so large that market disruptions are possible 1/9th of trillions of dollars is still a lot of money. But it's not like the Fed has to press a "sell" button.

BTW with T Bills that's ordinary monetary policy-- they do this all the time. QE is the greater than 1 year to maturity securities, primarily.

dodgy55
Posts: 4
Joined: Tue Jun 06, 2017 8:28 am

Re: How Does Fed Reduce Balance Sheet?

Postby dodgy55 » Fri Jun 16, 2017 10:28 am

Just want to thank all who spent a few minutes to explain how it works with the Fed redeeming bonds. Sifting through all the replies I gather that the Fed borrows cash from the Treasury and used it to do the QE program. Then that would explain how the Feds balance sheet can be reduced by returning the cash from maturing bonds back to the Treasury. I guess it is rather simple. thanks again

User avatar
Phineas J. Whoopee
Posts: 6381
Joined: Sun Dec 18, 2011 6:18 pm

Re: How Does Fed Reduce Balance Sheet?

Postby Phineas J. Whoopee » Fri Jun 16, 2017 9:09 pm

dodgy55 wrote:Just want to thank all who spent a few minutes to explain how it works with the Fed redeeming bonds. Sifting through all the replies I gather that the Fed borrows cash from the Treasury and used it to do the QE program. Then that would explain how the Feds balance sheet can be reduced by returning the cash from maturing bonds back to the Treasury. I guess it is rather simple. thanks again

You're welcome, but I'm afraid that's not correct at all.

The Fed, as invented and authorized by Congress, creates money. It doesn't need to get it from anywhere. The constraints are its dual mandate (full employment and generally stable prices, which are in tension with each other), its public nature, and Congressional oversight.

The Fed no more borrows from the Treasury than the Treasury borrows from the Fed.

In its routine operations, and in Quantitative Easing, when it buys securities the Fed creates the money, and when it sells or they mature the Fed destroys it. The Fed meets its expenses out of interest, and because there's almost always a lot left over it transfers the remaining interest to the Treasury, because what else would they do with it?

When the Fed buys securities of any term, it is creating Bank Reserves, which consist of two things: 1) Physical currency held in the banks' vaults; and 2) Money banks keep on deposit with their Regional Federal Reserve Bank, of which there are twelve. The commercial banks sell the Fed the bonds or some other derivatives, and the Fed credits their accounts with reserves for the amount agreed. When it sells, banks take the securities and the Fed debits their reserve accounts. Commercial banks are constrained in creating new money via lending by the fact they are legally required to keep a certain amount in reserve to meet withdrawals. It's approximately 10% of the value of all consumer checking accounts. Any excess reserves on deposit with a regional Fed bank are called Federal Funds.

When the Fed "raises interest rates," as it did two days ago, that means it sets a new target for the Federal Funds Rate, at which the most creditworthy banks lend excess reserves, please remember they're called Federal Funds, among themselves overnight, from the ones which happened to end the business day with more than required, to others which happened to end the day with too little. The way the Fed influences the rate each day is by buying or selling short-term Treasuries, or derivatives, in the open market, called Open Market Operations. By doing so they change the total supply of excess bank reserves and therefore its cost. By tradition from the days before fast and secure electronic communication the New York Fed carries out the trading.

The Fed's monetary policy setting body is its Open Market Committee.

PJW
Last edited by Phineas J. Whoopee on Fri Jun 16, 2017 10:07 pm, edited 2 times in total.

MEA
Posts: 86
Joined: Sat Jan 09, 2016 6:40 am

Re: How Does Fed Reduce Balance Sheet?

Postby MEA » Fri Jun 16, 2017 10:07 pm

Phineas J. Whoopee wrote:
dodgy55 wrote:Just want to thank all who spent a few minutes to explain how it works with the Fed redeeming bonds. Sifting through all the replies I gather that the Fed borrows cash from the Treasury and used it to do the QE program. Then that would explain how the Feds balance sheet can be reduced by returning the cash from maturing bonds back to the Treasury. I guess it is rather simple. thanks again

You're welcome, but I'm afraid that's not correct at all.

The Fed, as invented and authorized by Congress, creates money. It doesn't need to get it from anywhere. The constraints are its dual mandate (full employment and generally stable prices, which are in tension with each other), its public nature, and Congressional oversight.

The Fed no more borrows from the Treasury than the Treasury borrows from the Fed.

In its routine operations, and in Quantitative Easing, when it buys securities the Fed creates the money, and when it sells or they mature the Fed destroys it. The Fed meets its expenses out of interest, and because there's almost always a lot left over it transfers the remaining interest to the Treasury, because what else would they do with it?

When the Fed buys securities of any term, it is creating Bank Reserves, which consist of two things: 1) Physical currency held in the banks' vaults; and 2) Money banks keep on deposit with their Regional Federal Reserve Bank, of which there are twelve. The commercial banks sell the Fed the bonds or some other derivatives, and the Fed credits their accounts with reserves for the amount agreed. When it sells, banks take the securities and the Fed debits their reserve accounts. Commercial banks are constrained in creating new money via lending by the fact they are legally required to keep a certain amount in reserve to meet withdrawals. It's approximately 10% of the value of all consumer checking accounts. Any excess reserves on deposit with a regional Fed bank are called Federal Funds.

When the Fed "raises interest rates," as it did two days ago, that means it sets a new target for the Federal Funds Rate, at which the most creditworthy banks lend reserves among themselves overnight, from the ones which happened to end the business day with more than required, to others which happened to end the day with too little. The way the Fed influences the rate each day is by buying or selling short-term Treasuries, or derivatives, in the open market, called Open Market Operations.

The Fed's monetary policy setting body is its Open Market Committee.

PJW


The part I can't understand is how is all this connected to the stock market? If QE inflated the stock market then why aren't people worried the unwinding of QE will deflate the stock market? For years people attributed the rise in the market to QE. There is no worries that it's all going to be undone? It's hard to understand how all this works.
It is speculators speculating on other speculators speculations. It is a tale told by an idiot, full of sound and fury signifying nothing.

User avatar
Phineas J. Whoopee
Posts: 6381
Joined: Sun Dec 18, 2011 6:18 pm

Re: How Does Fed Reduce Balance Sheet?

Postby Phineas J. Whoopee » Fri Jun 16, 2017 10:18 pm

MEA wrote:...
The part I can't understand is how is all this connected to the stock market? If QE inflated the stock market then why aren't people worried the unwinding of QE will deflate the stock market? For years people attributed the rise in the market to QE. There is no worries that it's all going to be undone?

Which people in particular are you referring to, and why do you agree with them? I'm not saying there cannot ever be any connection, but when theory, in this case highly-partisan politically charged theory, and the world turn out to be different, it's theory or politics that must change, not the world.

Oh, and one more thing. Taken as a whole, 1Q2017 corporate earnings in the US came in notably higher than expected.

There is that.

PJW

AlohaJoe
Posts: 2080
Joined: Mon Nov 26, 2007 2:00 pm
Location: Saigon, Vietnam

Re: How Does Fed Reduce Balance Sheet?

Postby AlohaJoe » Fri Jun 16, 2017 10:35 pm

Of course there are worries. The Fed remembers the Tamper Tantrum, will be doing this very slowly, monitoring it the whole time, and will likely pause if they think things start to look off.

I'm not saying the Fed are always right - far from it - but people who assume they are outright stupid and incompetent have been repeatedly proven wrong over the past decade.

MEA
Posts: 86
Joined: Sat Jan 09, 2016 6:40 am

Re: How Does Fed Reduce Balance Sheet?

Postby MEA » Fri Jun 16, 2017 10:41 pm

Phineas J. Whoopee wrote:
MEA wrote:...
The part I can't understand is how is all this connected to the stock market? If QE inflated the stock market then why aren't people worried the unwinding of QE will deflate the stock market? For years people attributed the rise in the market to QE. There is no worries that it's all going to be undone?

Which people in particular are you referring to, and why do you agree with them? I'm not saying there cannot ever be any connection, but when theory, in this case highly-partisan politically charged theory, and the world turn out to be different, it's theory or politics that must change, not the world.

Oh, and one more thing. Taken as a whole, 1Q2017 corporate earnings in the US came in notably higher than expected.

There is that.

PJW


I didn't say I agree with them. I said "if"QE inflated the stock market. I'm just trying to understand the connection QE has to the stock market.
It is speculators speculating on other speculators speculations. It is a tale told by an idiot, full of sound and fury signifying nothing.

moshe
Posts: 405
Joined: Thu Dec 12, 2013 1:18 pm
Location: Boston, MA

Re: How Does Fed Reduce Balance Sheet?

Postby moshe » Fri Jun 16, 2017 11:35 pm

MEA wrote:
Phineas J. Whoopee wrote:
MEA wrote:...
The part I can't understand is how is all this connected to the stock market? If QE inflated the stock market then why aren't people worried the unwinding of QE will deflate the stock market? For years people attributed the rise in the market to QE. There is no worries that it's all going to be undone?

Which people in particular are you referring to, and why do you agree with them? I'm not saying there cannot ever be any connection, but when theory, in this case highly-partisan politically charged theory, and the world turn out to be different, it's theory or politics that must change, not the world.

Oh, and one more thing. Taken as a whole, 1Q2017 corporate earnings in the US came in notably higher than expected.

There is that.

PJW


I didn't say I agree with them. I said "if"QE inflated the stock market. I'm just trying to understand the connection QE has to the stock market.


1) Supply and demand for debt. Impact: change in interest rates. Secondary impact: chasing yield forces some market participants to buy/sell dividend(cash flow generating) equities.
2) increase / decrease in the total Money supply - impact: inflation/deflation.

If the fed is a buyer of debt in the open markets they create demand which causes debt prices to rise which causes an inverse in the market interest rates. The market/economy affecting theory is that lower interest rates allow for less expensive capital expenditures (capex) projects. Google "hurdle rate" if you want to know more about this. One can posit than many companies took advantage of lower than "normal" interest rates to issue debt for capex projects but also for stock repurchases which causes EPS to go up and the underlying stock price to go up as each share now represents a larger piece of the same pie (repurchased shares are retired). Please note that the fed, as noted above, creates the money out of thin air so they now own debt as an asset and "issued money" as a liability keeping their balance sheet in balance.

That issued money is now in the open market since they purchased this debt in the open markets and not from the treasury. This money in the hands of market participants can cause, at least in theory, inflation because more money in circulation will be chasing the same number of goods. The fed stated goal of 2% inflation has been illusive,at least so far. They fed is very afraid of deflation but that is a discussion for another thread perhaps.

Here is another impact on markets due to low interest rates. Market participants, in order to generate yield, may chase financial instruments that offer more cash flows (yield). These market participants that want higher than ~2.5% 10 year Treasury returns start chasing yield in the stock markets. If interest rates now go up and become more "normalized" the fear is that these same participants will sell their equities thus causing the markets to go down. This is why the fed is very likely to go slowly in reducing their balance sheet in order to influence the debt interest rates and money supply levels as slowly as possible.

~Moshe
My money has no emotions. ~Moshe | | I'm the world's greatest expert on my own opinion. ~Bruce Williams

onthecusp
Posts: 143
Joined: Mon Aug 29, 2016 3:25 pm

Re: How Does Fed Reduce Balance Sheet?

Postby onthecusp » Fri Jun 16, 2017 11:48 pm

Earlier it was stated that the Fed simply destroys the money it receives back when the bond expires, and gives the interest to the treasury.

Question: Why not destroy the interest money it receives as well? It is all money supply. Fungible. If destroying money is good (and I'm not arguing that unwinding QE is not good), would not this allow them to do it faster if they deem that to be a good idea?

bberris
Posts: 635
Joined: Sun Feb 20, 2011 9:44 am

Re: How Does Fed Reduce Balance Sheet?

Postby bberris » Sat Jun 17, 2017 7:24 am

onthecusp wrote:Earlier it was stated that the Fed simply destroys the money it receives back when the bond expires, and gives the interest to the treasury.

Question: Why not destroy the interest money it receives as well? It is all money supply. Fungible. If destroying money is good (and I'm not arguing that unwinding QE is not good), would not this allow them to do it faster if they deem that to be a good idea?

You could say that the interest is money destruction when it is returned to the Treasury. Just like your taxes are money destroyed. The fed does not destroy interest because, well, it's a bank. They have to follow accounting rules.
Also, some people seem surprised that the Fed can create money. All banks create money by making loans, which is what the Fed does when it buys securities. And all banks destroy money when a loan is payed off.

Stormbringer
Posts: 274
Joined: Sun Jun 14, 2015 7:07 am

Re: How Does Fed Reduce Balance Sheet?

Postby Stormbringer » Sat Jun 17, 2017 9:29 am

So imagine that the Fed prints $100 bills and lends them out (i.e. buys bonds). When those bonds mature, the $100 bills come back to the Fed. It could:

  • Lend them out to someone else.
  • Burn them.
  • Hand them over to the treasury to spend or repay public debt.
Until now, they've been doing the first thing, which returns the money back into the economy while maintaining the option to do the other two in the future.

The second point permanently withdraws those dollars from the economy, making dollars more scarce to create upward pressure on interest rates.

The third point is effectively financing government operations by printing money, which we might get away with to a point, but at some level usually causes huge inflation problems for countries that do it.

onthecusp
Posts: 143
Joined: Mon Aug 29, 2016 3:25 pm

Re: How Does Fed Reduce Balance Sheet?

Postby onthecusp » Sat Jun 17, 2017 10:45 am

bberris wrote:
onthecusp wrote:Earlier it was stated that the Fed simply destroys the money it receives back when the bond expires, and gives the interest to the treasury.

Question: Why not destroy the interest money it receives as well? It is all money supply. Fungible. If destroying money is good (and I'm not arguing that unwinding QE is not good), would not this allow them to do it faster if they deem that to be a good idea?

You could say that the interest is money destruction when it is returned to the Treasury. Just like your taxes are money destroyed. The fed does not destroy interest because, well, it's a bank. They have to follow accounting rules.
Also, some people seem surprised that the Fed can create money. All banks create money by making loans, which is what the Fed does when it buys securities. And all banks destroy money when a loan is payed off.


OK, I understand following accounting rules, I suppose that separating the two sources of money is more neutral with respect to inflation and separates actions on purpose from more random effects.

As for taxes being money destroyed it seems more a point of view. Since we are always in deficit spending, taxes are money that does not have to be created by issuing more bonds. That is the same net result as destroying the money and just issuing bonds for the entire budget. Except there is no interest obligation. At the other extreme if our govt. operated on cash, then taxes would be simply what we paid for govt. services and that is not destruction at all.

Blender
Posts: 130
Joined: Wed May 13, 2015 10:56 am

Re: How Does Fed Reduce Balance Sheet?

Postby Blender » Sat Jun 17, 2017 10:51 am

MEA wrote:The part I can't understand is how is all this connected to the stock market? If QE inflated the stock market then why aren't people worried the unwinding of QE will deflate the stock market? For years people attributed the rise in the market to QE. There is no worries that it's all going to be undone? It's hard to understand how all this works.

QE pushes down interest rates. Low interest rates drives more money into stocks due to lower yields on bonds. Companies can also borrow and grow a lot cheaper with the lower cost of capital. I don't see how this is political or why politics is trying to be injected into this conversation.

User avatar
Simplegift
Posts: 2280
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: How Does Fed Reduce Balance Sheet?

Postby Simplegift » Sat Jun 17, 2017 11:41 am

MEA wrote:The part I can't understand is how is all this connected to the stock market? If QE inflated the stock market then why aren't people worried the unwinding of QE will deflate the stock market? For years people attributed the rise in the market to QE. There is no worries that it's all going to be undone? It's hard to understand how all this works.

There’s not a clear consensus among economic researchers today about just how much impact QE has actually had on U.S. stock prices. The conventional wisdom is that lower interest rates — by lowering the discount rate that investors use — have led to an increase in the present value of future corporate cash flows, boosting stock market valuations.

But other researchers conclude that the effect of QE on equity prices may not have been all that significant. To better understand the arguments of those in this latter camp, this brief article by McKinsey and Company has a good outline: What Effect has Quantitative Easing had on Your Share Prices?

If this latter argument is correct, the tapering of QE is not likely to have a major, lasting impact on stock prices.
Cordially, Todd

User avatar
Simplegift
Posts: 2280
Joined: Tue Feb 08, 2011 3:45 pm
Location: Central Oregon

Re: How Does Fed Reduce Balance Sheet?

Postby Simplegift » Sat Jun 17, 2017 3:55 pm

It’s worth pointing out that QE is not just a U.S. phenomenon, but a global one (chart below). China’s central bank (PBoC, in red) has been “tapering” for years, along with the U.S. Federal Reserve more recently. Europe (ECB, in blue) is expected to begin tapering over the next few years — while Japan keeps adding to its central bank balance sheet, but with disappointing economic results.

In the years ahead, markets worldwide may have to adapt to a general decline in the massive bond purchases by central banks — with uncertain consequences for interest rates and asset prices in both domestic and international markets.
Cordially, Todd

User avatar
nedsaid
Posts: 7537
Joined: Fri Nov 23, 2012 12:33 pm

Re: How Does Fed Reduce Balance Sheet?

Postby nedsaid » Sat Jun 17, 2017 4:20 pm

dodgy55 wrote:As a result of it's Quantitative Easing program the Federal Reserve has substantially increased it's balance sheet. Now the Federal Reserve is looking to reduce its balance sheet by a few trillion. Not sure if my current musing falls into this investment forum but for the life of me, I cannot figure out the Fed Reserve goes about reducing a balance sheet. To acquire the treasury bills for it's QE program it had to print bundles of $. A corporation can reduce a balance sheet by spinning off a division or incurring an operating loss. However, this does not apply to the Fed Reserve. I am sure there is a simple answer but just can't think of it. Can somebody explain to me how the Fed can reduce it's balance sheet?


The Fed will let bonds mature and not reinvest. As I recall, they went out and purchased mortgage backed bonds as part of quantitative easing in addition to the Treasury instruments that it has historically purchased when it wants to put money into the financial system. My best guess is that they will let the mortgage backed bonds mature and reinvest most maturing treasuries back into the Treasury market. The process of letting bonds mature and not reinvesting will in effect reduce the money supply a bit.

Phineas J Whoopee gave a good summary of the role of the Fed in money creation. It seems that most monies are actually created in the private banking system through the money multiplier effect. Budget deficits also have a smaller but important effect on the money creation process. What creates money in the economy in order of importance seems to be this: 1) money creation through the money multiplier in the private banking system, 2) the Fed creating money out of thin air when buying debt instruments for its balance sheet, and 3) Congress authorizing deficit spending. The private economy can create money as when a vendor extends credit to its customers.
A fool and his money are good for business.

User avatar
Oicuryy
Posts: 1104
Joined: Thu Feb 22, 2007 10:29 pm

Re: How Does Fed Reduce Balance Sheet?

Postby Oicuryy » Sat Jun 17, 2017 4:50 pm

I drew this graph a few years ago to see if I could see any effect of the big increase in the monetary base (QE), the dark green line, on some other economic measures.
Image
https://fred.stlouisfed.org/graph/?g=e89i

Ron
Money is fungible | Abbreviations and Acronyms

User avatar
Doc
Posts: 7156
Joined: Sat Feb 24, 2007 1:10 pm
Location: Two left turns from Larry

Re: How Does Fed Reduce Balance Sheet?

Postby Doc » Sun Jun 18, 2017 4:12 pm

Valuethinker wrote:As per others, by letting the securities mature (get repaid by the issuer) and then not "rolling" that money into new bonds.

I am sure it is published somewhere, but my guess is the duration of the QE portfolio would be around 8-9 years. So, roughly speaking, 1/9th expires every year.

Janet Yellen addressed the amount they would not roll over various time frames in her speech last week but I ignored the amounts as having more 0's than I can comprehend.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

User avatar
Doc
Posts: 7156
Joined: Sat Feb 24, 2007 1:10 pm
Location: Two left turns from Larry

Re: How Does Fed Reduce Balance Sheet?

Postby Doc » Tue Jun 20, 2017 11:55 am

While on hold to Schwab today I listened to their "market update" which they use for hold music. Came upon this:

Kathy A. Jones, Schwab wrote:Will the Fed Reduce Its Balance Sheet? What Bond Investors Should Know

Key Points

We expect the Federal Reserve to announce by the end of this summer a plan to reduce its balance sheet by about $1.5 trillion. The prospect of such a large reduction in bond holdings has investors nervous about the potential impact on yields.

But we don’t believe it should be cause for alarm. The Treasury market should be able to absorb a gradual decline in the Fed’s bond holdings without pushing yields significantly higher. The impact on the mortgage-backed securities market might be greater, however.

If bond yields head higher during the next few years, it is more likely to be the result of stronger growth and inflation than the size of the Fed’s balance sheet.

http://www.schwab.com/public/schwab/nn/ ... hould-Know

Fed Portfolio:
Image

Note the article was written before the June FOMC meeting.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

Thesaints
Posts: 118
Joined: Tue Jun 20, 2017 12:25 am

Re: How Does Fed Reduce Balance Sheet?

Postby Thesaints » Tue Jun 20, 2017 12:13 pm

QE has essentially created inflation limited to financial assets.
By targeting a higher consumer inflation level they are hoping for the value of money to eventually catch up with the value of those assets in a painless way.
They have not succeeded up to now, because higher CPI can only be achieved through higher salaries, which are not coming, or lower production of consumer goods/services, which is undesirable.
They are now trying to deflate financial assets by increasing bond yields. That is a dangerous maneuvre, since it also increases government interest expense and with the Republican party in power that could mean much lower public expenses, which could trigger a recession.

My view is that the Fed has to keep the door nominally open for higher rates and occasionally they have to show their intent to maintain credibility, but low rates are going to stay for the foreseeable future.
Japan, for different, but also for some similar reasons, has been in this low inflation/low rates situation as far back as man can remember.


Return to “Investing - Theory, News & General”

Who is online

Users browsing this forum: MIpreRetirey and 39 guests