Fed’s QT: Net assets fell $91 billion from peak (QE made money, QT destroyed money)

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 a three-month phase-out. Total Assets at the Fed weekly balance sheet As of August 3rd, issued this afternoon, it fell by $17 billion from the previous week and $91 billion from the peak in April to $8.87 trillion, the lowest since February 2.

QE created money that the Fed pumped through its primary dealers into financial markets, from where it began circulating and chasing assets including non-financial markets such as housing and commercial real estate. The purpose and effect was to suppress yields and create asset price inflation. And it also ultimately helped drive up consumer price inflation.

Qt does the opposite: it destroys money and has all the opposite effects – not for day-traders but in the long term. Qt is one of the tools the Fed is now using to crack down on consumer price inflation.

Treasury Securities: – $52 billion from peak.

July: – Roll-off of $30 billion +$4.6 billion in TIPS inflation compensation.

Treasury notes and bonds are closed in the middle of the month and mature at the end of the month. Today’s balance sheet includes the roll-off at the end of July.

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

The Fed currently has $374 billion in TIPS. Inflation compensation amounts to approximately $1 billion to $1.5 billion per balance sheet week, or approximately $4 billion to $5 billion per calendar month, which connects for the balance of Treasury securities.

The QT phase-in plan (from June to August) calls for the Fed to roll off $30 billion of Treasury securities per calendar month as they mature. And the Fed did exactly that in July.

So why did Treasury securities fall by only $25.2 billion, and not the $30 billion that tumbled? Tips Inflation Compensation!

  • The Fed allowed $30 billion in Treasuries to roll over without replacement, which Reduced The remaining $30 billion.
  • The Fed received $4.6 billion in inflation compensation from the government. increased remaining $4.6 billion
  • Net effect: The total balance fell by $25.2 billion.

Adding Inflation Compensation to the Balance of Treasury Securities everyone Hence the reduction in balance will be less every month as compared to the actual roll-off.

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

The amount of Treasury securities has now fallen by $52 billion to $5.72 trillion from a June 6 peak, the lowest since January 26:

MBS, strange creatures with great delay.

How to exit from MBS Balance Sheet:

  • Pass-Through Basic Payment – Primary Mode
  • When the Issuer “Calls” the MBS
  • They are usually “called” when MBS mature, but before they mature.
  • When the Fed sells them, which it has said it may do so someday in the future.

pass-through principal payment: When the underlying mortgage is paid off (due to the sale or refinance of the property) or when the regular mortgage payment is made, the mortgage servicer (the company to which you send the mortgage payment) forwards the principal payment to the entity that made the MBS (such as Fannie Mae), which then forwards those principal payments to holders of MBS (such as the Fed).

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

The issuer “calls” the MBS, After a good number of pass-through principal payments, the remaining book value of the MBS may decline so much that it is no longer worth servicing the MBS, and the issuer, such as Fannie Mae, decides to “call” the MBS balance. The mortgagee will repackage the loan with other mortgages into new MBS. When Fannie Mae “calls” MBS, they are taken off the Fed’s balance sheet.

When MBS matures. MBS has a maturity of 15 years or 30 years. But this is largely irrelevant because the average age of mortgages in the US is less than 10 years as they are paid off by sale or ref. And when the remaining book value of MBS falls below a certain level, the issuer calls them, and removes them from the book.

How does MBS arrive on the balance sheet?

The Fed buys MBS in the “To Be Announced” (TBA) market during QE, and to a lesser extent during tapers, and to a lesser extent in June and July. The June and July purchases are designed to replace the June and July pass-through principal payments that exceeded the monthly limit of $17.5 billion.

But it takes one to three months to settle the purchase in TBA market. The Fed books its trades after they settle.

So the influx of MBS over the last few weeks comes from trades that were executed a few months ago prior to Qt. What we are seeing now are purchases made during the taper.

These purchases do not align with the pass-through principal payments the Fed receives. This misalignment, and the three-month lag, creates the volatility of the MBS balance, which is then reflected in the overall balance sheet as well.

MBS: – $23 billion from peak to $2.72 trillion:

Unmodified Premium: Continually declining.

All buyers pay a “premium” to purchase a bond if that bond’s coupon interest rate is higher than the market yield at the time of purchase.

The Fed books securities at face value in regular accounts and it books the “premium” in a special account, the “unmortized premium.” The Fed then reduces the premium to zero on the remaining maturity of the bond, while it receives higher coupon interest payments at the same time. By the time the bond matures, the premium has been fully amortized, and the Fed receives the face value, and the bond is taken off the balance sheet.

The “unmortized premium” peaked in November 2021 with the start of the taper at $356 billion and has now fallen from $26 billion to $330 billion in a steady process:

Other QE and bailout assets are largely liquidated,

  • Special Purpose Vehicle (SPV) through which the Fed purchased bonds, loans and ETFs: $38 billion
  • Central Bank Liquidity Swap: $0.2 billion.
  • Repo: $0

When Money-Printing Comes to Settlement:

In the 15 years of this chart, there have been three crises: the financial crisis, the pandemic, and now rising inflation. Today’s inflation crisis is pulling in the opposite direction of the two previous crises, and tackling it will require the use of tools in the opposite direction:

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