Fed Balance Sheet: July 2021

The latest month of 143B added was above average

This article first appeared on SchiffGold.

Introduction

The Federal Reserve has three primary tools to conduct Monetary Policy: reserve requirements, the discount rate, and open market operations (Quantitative Easing). Open market operations is how the Fed uses its balance sheet to provide liquidity to the market. More details can be found here. The Fed defines Open Market Operations as:

Open market operations involve the buying and selling of government securities. The term “open market” means that the Fed doesn’t decide on its own which securities dealers it will do business with on a particular day. Rather, the choice emerges from an “open market” in which the various securities dealers that the Fed does business with – the primary dealers – compete on the basis of price. Open market operations are flexible, and thus, the most frequently used tool of monetary policy.

This is a fancy way of saying the Fed prints money to buy up US debt, providing liquidity while also keeping interest rates low. Essentially, Quantitative Easing (QE) is debt monetization. This analysis explores the changes in the Fed balance sheet to better understand what the Fed is buying and when.

Recent Trends

The latest balance sheet figures show the total at 8.22T, up 143B from the prior month end, but down in the past week by 19B. The chart below shows how the Fed Balance sheet has grown by instrument over the last 18 months. The major surge from COVID can be clearly seen as 2.5T was added within 2 months. The monthly changes since reflect QE on autopilot. Autopilot targets about 120B in monthly purchases split by 40B in MBS and 80B in US Treasuries. As the numbers show, this is not exact, but an approximation.

The “Other” category surged and fell last year due to Repurchase Agreements. This is the opposite of the Reverse Repos. In standard Repo Agreements, the Fed buys from a dealer with an agreement to return the security. This was designed to be temporary in nature rather than a permanent add to the balance sheet. These repurchase agreements put a floor under the treasury market by providing unlimited liquidity.

Figure 1: Monthly Change by Instrument

The table below shows the breakdown of holdings by instrument and the period over period change as indicated. The main takeaways:

• The balance sheet has grown by 1.27B over the last year, averaging about 100B a month rather than the target of 120B
  • More recent months are trending above this average and target
• The balance sheet grew by $4T over 3 years, the majority of which occurred since the start of Covid
• In the latest month, the focus has been on MBS(65B) and Shorter term treasuries of 1-5 years (39B)
• The Fed is not putting much emphasis on short term debt adding only 63B over 1 year
  • The market for short term treasuries is still very liquid and does not need Fed support
  • Almost 40% of the Treasury Balance sits in 1-5 year maturing debt with another 40% in 5+
• MBS has grown by 451B over the last year and Treasuries have grown almost 1T

The chart below shows the percent distribution by product. While absolute values have increased quite significantly as shown in the table above, the distribution of holdings has changed some. MBS made up 40% of the balance sheet 3 years ago, but the number has fallen to under 30% as short term (<1 year) and medium term (5-10 years) has increased from 9% to 12.6% and 7% to 11.7% respectively.

Figure 2: Total Debt Outstanding

Zooming into weekly

Another chart to look at is the weekly change in the balance sheet. Anyone who follows the balance sheet closely, will notice it dips once a month before jumping back up. The chart below shows how the fed balance sheet changes week over week. As seen, there are a few consistent trends:

• A series of MBS Mature about every four weeks
  • This results in a slight decrease in the balance sheet for that week
• A bulk of MBS is also bought every 4 weeks that is larger then the maturing MBS
  • This creates a surge in the balance sheet for that week
• Treasury securities mature and are purchased with less volatility

The latest week saw 37B in MBS mature with 20B in Treasuries purchased. It is likely that in 2 weeks there will be a large purchase of MBS.

Figure 3: Fed Balance Sheet Weekly Changes

The table below shows how the latest week compares to the weekly averages over 4, 24, 52, and 156 (3 years) weeks. The weekly averages are shown to gauge whether the current periods (1 and 4 weeks) are accelerating or decelerating. The averages are all divisible by 4 because that is about how many weeks a full cycle takes as shown in the plot above.

The Fed has averaged about 35B per week for 4 weeks totaling 140B, which is slightly above the 120B monthly target. The latest week saw a more than 50% increase in debt maturing in 1-5 years compared to the 4, 24, and 52 week averages. Perhaps this helped drive the 2-year rate from 25bps back to 20bps over the last two weeks.

Historical Perspective

As mentioned, the Fed is monetizing US Debt. The chart below uses the data from the debt analysis and matches it up with the Fed balance sheet holdings. While this is not a perfect one to one match due to the nature of reporting, the outcome can be seen below. This chart focuses specifically on Treasury securities: Bills (<1 Year maturity), Notes (1-10 year), and Bonds (10+ years). This is the bulk of debt issuance and Fed purchases.

As can be seen below the Fed has monetized a large percentage of debt issued since Jan 2020. The focus is clearly seen in Notes and Bonds to keep a lid on long term rates. The first chart shows the debt added in each of the last 4 years by instrument. The bottom chart shows the percent of that debt the Fed has purchased. In 2020, the Fed monetized more than 100% of notes and 90% of bonds. In 2021 those numbers have fallen to 35% and 46% respectively. While not a complete monetization, this is still massive in terms of scope.

Figure 4: Debt Issuance by Year and Instrument

Figure 5: Fed Purchase % of Debt Issuance

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 tapering from 2017-2019 can be seen in the slight dip before the massive surge due to Covid.

There is no way the Fed will come close to shrinking the balance sheet at this stage. With more Fiscal spending on the horizon and an economy addicted to low interest rates, it is probable that the growth of the balance sheet may accelerate rather than decelerate.

Figure 6: Historical Fed Balance Sheet

What it means for Gold and Silver

The Fed is in a box. They cannot let interest rates rise or else the entire economy will come crumbling down, but if they keep the monetary stimulus flowing then inflation will most likely spiral. As shown above, they have monetized a huge amount of the US Debt this year (~40%). The government needs this monetary support or else rising long term rates will put pressure on the Federal Deficit.

The Fed can talk about tapering and even make attempts to do so, but they will inevitably reverse course and begin expanding their balance sheet by more than $120B a month. The will continue driving the Money Supply higher putting downward pressure on the dollar and upward pressure on inflation. Do they have the tools to fight inflation? Absolutely. But the implications of doing so are so politically devastating that they will choose higher inflation over a collapsing economy. Gold and silver will provide excellent protection during this time.

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Data Source: https://fred.stlouisfed.org/series/WALCL and https://fred.stlouisfed.org/release/tables?rid=20&eid=840849#snid=840941

Data Updated: Weekly, Thursday at 4:30 PM Eastern

Last Updated: Jul 28, 2021

Interactive charts and graphs can always be found on the Exploring Finance dashboard: https://exploringfinance.shinyapps.io/USDebt/