Breaking Down the Balance Sheet
The Fed saw a reduction in its balance sheet of $143B during April. Standard QT was responsible for $83B while $55B of the reduction was in Repurchase (Repo) Agreements which dropped to $0 this week. While Repos dropped to zero, Loans actually increased for the week, despite being down slightly for the month by $8.6B.
The Fed has failed again to hit the MBS $35B target, seeing only an $18B reduction. This should come as no surprise as the Fed has never come close to its MBS target. In fact, last month was the closest the Fed ever came, with a $25B reduction in MBS.
Figure: 1 Monthly Change by Instrument
The table below provides more detail on the Fed’s QT efforts.
- Treasuries saw a net reduction of $63.7B which was on the QT target
- Reduction was focused in the 1-10 year range
- Less than 1 year and greater than 10 year actually saw an increase of $8.4B
- As mentioned above, MBS saw a reduction of $18.2B, but $17.2B came in the latest week
- Repos dropped from $55B to $0, but this was entirely in Foreign
- Loans fell by $8.6B on the month but actually increased by $8.6B on the week
- “Other” increased by $2.6B
- Treasuries saw a net reduction of $63.7B which was on the QT target
Loans are broken down into multiple categories, the three biggest being Primary Credit ($73B), Bank Term Funding Program ($81B), and Other Credit Extensions ($170B). The first two actually increased on the week by $4B and $7.5B.
Figure: 2 Balance Sheet Breakdown
The weekly activity can be seen below. This is actually the second week in a row that Loans have increased.
Figure: 3 Fed Balance Sheet Weekly Changes
The chart below shows the balance on detailed items in Loans and also Repos. Primary Credit is still below the high seen in March, but the Bank Term Funding Program (BTFP) has reached a new all-time high, suggesting that the banking crisis has not yet passed. Other Credit Extensions also remain elevated.
Figure: 4 Loan Details
With the Fed’s aggressive rate hikes, yields across Treasuries have gotten extremely congested. As the chart below shows, the 2-30 year are all stuck together. Since the collapse of SVB in early May, rates have fallen into a tight range between 3.5% and 4.5%.
Figure: 5 Interest Rates Across Maturities
As the yield curve has grown more congested, the yield curve inversion has fallen some. The 2 to 10-year inversion is at -47bps. On March 8th the inversion exceeded 100bps! Regardless, the yield curve is still inverted and has been since July 5th last year. An extended inversion only increases the chances of a recession. Most would consider a recession inevitable at this point. Even the Fed is calling for the possibility of one.
Figure: 6 Tracking Yield Curve Inversion
The chart below shows the current yield curve, the yield curve one month ago, and one year ago. The change over the past month has been minimal, but the change from a year ago is quite dramatic.
Figure: 7 Tracking Yield Curve Inversion
The Fed Takes Losses
The Fed has recently accumulated about $52B in total losses. This is driven by two factors:
- Similar to SVB, it is selling assets (under QT) that are now worth less than when they bought them
- The interest paid out to banks (4%+) is greater than the interest it receives from its balance sheet (2%)
When the Fed makes money, it sends it back to the Treasury. This has netted the Treasury close to $100B a year. This can be seen below.
Figure: 8 Fed Payments to Treasury
You may notice in the chart above that 2023 is showing $0. That’s because the Fed is losing money this year. According to the Fed: The Federal Reserve Banks remit residual net earnings to the U.S. Treasury after providing for the costs of operations… Positive amounts represent the estimated weekly remittances due to U.S. Treasury. Negative amounts represent the cumulative deferred asset position … deferred asset is the amount of net earnings that the Federal Reserve Banks need to realize before remittances to the U.S. Treasury resume.
Basically, when the Fed makes money, it gives it to the Treasury. When it loses money, it keeps a negative balance by printing the difference. That negative balance has just exceeded $52B!
Figure: 9 Remittances or Negative Balance
Note: these charts are a correction to earlier articles that aggregated the Fed’s negative balance, overstating the losses.
Who Will Fill the Gap?
The Fed has been absent from the Treasury market for a year. The debt ceiling has kept debt issuance low for the last several months, but once the debt ceiling is raised (and make no mistake – it will be raised), some party needs to absorb all the new debt. The government budget deficit has gotten much worse in a hurry with spending going up as tax revenue falls. The Treasury will be issuing a lot of debt in the months and years ahead. If the Fed sticks to QT, then they will only add to the selling pressure in the market.
International holdings have been stagnant since July 2021 at around $7.5T. With the Treasury set to issue $2T a year combined with the Fed selling $65B a month, that is a lot of debt for the market to absorb.
Note: data has not been updated for February yet and was last updated for January on March 15
Figure: 10 International Holders
It should be noted that both China and Japan (the largest international holders of Treasuries) have been reducing Treasury holdings. Over the last year, they have reduced holdings by a combined $40B. Again, this should come as no surprise as talk of the dollar reserve status has been questioned by even the mainstream media. Foreign countries are trying to get rid of their US debt!
Figure: 11 Average Weekly Change in the Balance Sheet
The final plot below takes a larger view of the balance sheet. It is clear to see how the usage of the balance sheet has changed since the Global Financial Crisis.
The recent moves by the Fed in the wake of the SVB collapse can also be seen below. When the next break in the economy occurs, it’s likely that the balance sheet will spike again.
Figure: 12 Historical Fed Balance Sheet
While the aggregate balance sheet looks to be shrinking, the detailed data shows it is more complex than that. The Repo agreements have gone back to $0 so nothing more will be rolling off. The question now becomes, how much do loans change over the coming weeks and months? If it continues to increase, then it indicates further signs of stress in the banking sector.
Furthermore, the Treasury math is pretty simple. The government will be issuing trillions of dollars of debt per year in perpetuity. The rest of the world is openly trying to get rid of the US dollar dependence, which means less accumulation and even selling of US Treasuries. The Fed cannot keep to QT and expect the Treasury market to survive unscathed.
As mentioned many times, something else is going to break. It’s not about “if” but “when”. Anyone who is currently denying the reality of recession will be in for a rude awakening. Now that the Fed has acknowledged the possibility of a recession, they will be ready to “solve” the problem with all their old tricks (i.e., lowering rates and printing money). The one thing they still have wrong is the severity. When this recession kicks into high gear, the Fed will be pulling every tool out of its toolkit to try and rescue the economy. At that time, they will undo all their QT and then some even quicker than they did in March with the SVB collapse.
Once this becomes a reality, the market will have to reprice a lot of assets. Gold and silver stand to benefit the most. Some astute investors seem to be aware of this reality and have been pillaging the Comex for all the physical metal they can get their hands on.
Data Updated: Weekly, Thursday at 4:30 PM Eastern
Last Updated: Apr 26, 2023
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