It sticks to the plan, QT like clockwork: what the Fed has done in detail and charts, and my super geeky extra-fun dive into the “to be announced” market for MBS.
By Wolf Richter for WOLF STREET.
The Federal Reserve’s quantitative tightening (QT) ended its three-month phase-in period on August 31. months by letting them mature without replacement, and allowing its mortgage-backed securities (MBS) to fall by as much as $17.5 billion a month, mostly from pass-through principal payments.
In September, the pace of QT roughly doubles, with caps doubling to $60 billion per month for Treasuries and $35 billion for MBS. So how did it go in August?
Total assets on the Fed weekly review as of August 31, released September 1, fell $25 billion from the previous week, $48 billion from the August 3 balance sheet and $139 billion from the April 13 peak, to $8.83 trillion, lowest since Jan. 12.
QE created money that the Fed injected into financial markets by buying securities from its primary traders, who then sent that money out to find assets in financial markets and other markets, including including residential and commercial real estate, all of which inflated asset prices, and drove down yields and mortgage and other interest rates, which was the express purpose of QE.
And at the start of 2021, QE suddenly helped fuel the runaway consumer price inflation that the Fed has now pledged to combat with rate hikes and, you guessed it, QT.
QT has the opposite effect of QE: it destroys money, drives up yields, pulls the rug out from under asset price inflation, and helps bring down consumer price inflation. .
QT is straightforward with regular Treasury securities, complicated only by the Fed’s holdings of Treasury Inflation Protected Securities (TIPS). But MBS are a different creature, as we’ll see in a moment.
Treasuries: Down $76 billion from the peak.
Treasury bills and bonds sell out in the middle of the month and at the end of the month when they reach maturity. Today’s balance sheet includes the August 31 roll-off.
TIPS pay compensation for inflation (income). But it is not paid as coupon interest. Instead, it is added to the main TIPS value. When TIPS mature, holders receive the amount of the original face value plus the accumulated inflation compensation that has been added to the principal over the years (similar to your I-Bonds).
- Treasury bills and bonds: down $30.4 billion.
- TIPS Inflation Compensation: Up $6.0 billion, earned and added to TIPS Principal.
- Net change: -24 billion dollars compared to the August 3 balance sheet.
This inflation offset of about $1.5 billion a week is income the Fed earns that will be paid in cash by the Treasury Department when the TIPS mature. The Fed adds this income to the weekly TIPS balance. You can see this in the chart below in the slight upward slope of the period following the end of QE in mid-March and until June 6, before the start of QT.
MBS, creatures with a big lag: $31 billion below peak.
We’re going to be doing some super special geeky stuff today, a deep dive into WOLF STREET in MBS fed trades in the market to be announced (TBA) which I’ve uploaded to my server and will walk you through one moment. It will undoubtedly be the most fun you have ever had. But before we get to that…
MBS exit the balance sheet primarily through passed-on principal payments. When the underlying mortgages are paid off due to a home sale or refi, or when regular mortgage payments are made, the principal portion is forwarded by the mortgage servicer (such as your bank) to the entity that securitized the mortgages (like Fannie Mae), which then passes on those principal payments to MBS holders (like the Fed).
The book value of MBS decreases with each principal payment transmitted. This reduces the amount of MBS on the Fed’s balance sheet. These direct principal payments are irregular and unpredictable.
MBS are on the balance sheet 1-3 months after the Fed buys them on the “To Be Announced” (TBA) market.
And that’s what we’re going to have fun with now.
Purchases on the TBA market take one to three months to settle. The Fed books its transactions after they have been settled.
I uploaded to the WOLF STREET server the spreadsheet I downloaded from the New York Fed containing part of its MBS operations in the TBA market. To make the walkthrough easier to follow, I’ve color-coded the worksheet (download my “NYFed_MBS-ops” spreadsheet here).
The spreadsheet shows how each of the MBS enters the Fed’s balance sheet and how long the lag is for each MBS:
- I marked in red: all MBS purchases settled in August (settlement date = column J). They settled on August 11, August 16 and August 18.
- The Fed’s weekly report is always dated Wednesday and released on Thursday.
- MBS settled on August 18 appeared on the August 24 balance sheet, but coincided with a large pile of principal payments that ended up dominating lean purchases and reducing the balance that day.
- The MBS that settled on August 11 and 16 appeared on the August 17 balance sheet, and you see how the MBS balance has grown.
- Now go to column C (yellow) “Trade date”, when the MBS was purchased on the TBA market.
- I have marked the MBS that were purchased in June in bold red (column C). And they appeared three months later on the August 17 and August 24 balance sheets.
- Now go to what the Fed bought in May, before QT, which I have marked in green (column C = dates of purchase). There are a lot of them, $108 billion (I added them up in column Y). Keep scrolling to line 265 to see them all.
- In column J (settlement dates), you see the MBS that the Fed bought in May, before QT, settled in June and July, during QT, i.e. when they appeared on the balance sheet. That’s why people thought the Fed wasn’t doing QT.
Wasn’t that hilarious fun? I thought so!
The Fed is doing exactly what it said it would do; you just need to understand the mechanics of the TBA market and the balance sheet.
MBS: down $31 billion from peak at $2.71 trillion:
Unamortized premiums: down $29 billion from the peak at $327 billion.
All bond buyers pay a “premium” on face value when buying bonds when the coupon interest rate on that bond is higher than the market yield at the time of purchase for that maturity.
The Fed tracks securities at face value in regular accounts, and it tracks “premiums” in an account it calls “unamortized premiums.” The Fed then amortizes the premium of each bond to zero over the remaining term of the bond. At the same time, he receives higher coupon interest payments. By the time the bond matures, the premium has been fully amortized, the Fed receives its face value, and the bond leaves the balance sheet.
“Unamortized premiums” peaked in November 2021 at $356 billion and have now steadily declined from $29 billion to $327 billion:
For your amusement, how we got to Raging Inflation:
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