They call it “easy money.” We live in a world where the flick of a switch or click of a mouse can create billions to trillions of dollars which are then loaned out to certain members of our society. That said, paying back that money is not as easy…
In the case of the Fed’s $7.9 trillion balance sheet, when will this get repaid? Where will that money come from?
The Federal Reserve buys approximately $80 billion US Treasury and $40 billion Mortgage-Backed Securities (MBS) a month. These “temporary” purchases are claimed to provide market liquidity during times of crisis to help correct for errors caused by the free market.
Over the last week, we were given hints of things to come. In Monday’s publication of the Open Market Operations During 2020 report, by the Federal Reserve Bank of New York much was said about the System Open Market Account (SOMA), the portfolio which includes both domestic and foreign assets. Per projections in the report:
Treasury and agency MBS purchases continue at the current pace through 2021 before gradually reducing to zero at the end of 2022.
If reducing purchases of treasuries and MBS to NIL at the end of 2022, after hitting $9 trillion in assets seems unbelievable, understand it doesn’t end there. More details of the plan are provided:
By the end of the projection horizon, the size of the portfolio could be as low as $6.6 trillion or as high as $9.0 trillion…
They included a chart showing the high and low ranges in the shaded region below:
The notion of tightening the balance sheet continues to gain in popularity among prominent central bankers. Even Vice Chair Richard Clarida gave an interview to Yahoo Finance saying:
There will come a time in upcoming meetings where we’ll be at the point where we can begin to discuss scaling back the pace of asset purchases…
The Philadelphia Fed President, Patrick Harker, was more descriptive suggesting a discussion regarding tapering should happen:
sooner rather than later.
How soon is “sooner” and how late is “later?” Everyone knows the Fed cannot continue to buy assets indefinitely; yet, it’s difficult to picture a world where the Fed does not buy assets indefinitely. The effects on various markets, such as stock, bonds, or housing seem unfathomable.
Without the Fed buying bonds, interest rates will likely go up… unless another entity such as another central bank or the public steps in to fill the void. Considering an ever-growing government debt and stimulus programs now seemingly permanent, few could imagine where this easy money would be without the help of the Fed.
As for the stock market, higher rates change valuations and investment decisions, as well as the cost of borrowing. But this goes beyond rates. The Fed’s $7.9 trillion balance sheet, or portfolio holding, as mentioned before is really an account receivable balance. The existing $7.9 trillion means someone owes the Fed this money. By 2023, should the Fed decide to “taper,” i.e. shrink its balance sheet by $2 trillion until 2030, this money will have to be withdrawn from the system…somehow.
Whether from reserves held at the Fed, bank institution balance sheets, or the stock market itself remains to be seen. As of May 25, the total reserves of depository institutions, i.e., money banks held at the Federal Reserve, stood at a whopping $3.89 trillion!
Untangling which entities have money parked at the Fed and who has a claim on the funds would take deciphering, if even possible for the public to ever know. But the point is: to reduce the Fed’s balance sheet by $2 trillion requires $2 trillion to come from somewhere; yet, there are only so many places a few trillion dollars can be housed. If funds are not withdrawn from Fed deposits to pay back the Fed, it must be withdrawn from other markets, such as stocks or bonds. When, if ever, the debt is called to be repaid, we can expect to see some “interesting changes” to all financial markets… and that’s putting it mildly.
THIS ARTICLE ORIGINALLY POSTED HERE.