The Fed’s “Big Shift”
There have been endless announcements by the Fed that they will add this and that to their asset-purchase programs. The media jumped all over these announcements, how the Fed is going to get into the junk bond market and ETFs with hundreds of billions of dollars.
Each time, all kinds of hoopla broke out in the markets with stocks soaring and junk-bond ETFs soaring, and everything soaring — despite the worst economy in memory, despite 30 million people on unemployment insurance, and despite shocking earnings reports heading our way.
The Fed has set up an alphabet soup of programs so far — and it has been buying some of the assets it said it would buy.
In all, the Fed has indirectly monetized about 65% of the government debt it’s taken on since March. But here’s what you might not realize:
The Fed’s monetization of the U.S. debt has slowed to a trickle in recent weeks after the original shock-and-awe spree in March and April, whittling down its purchase programs of Treasuries.
It also has been shedding alphabet-soup assets it had bought in March and April, and cutting back its purchases of mortgage-backed securities (MBS) for the past two months.
And believe it or not, total assets on the Fed’s balance sheet actually shrank by $74 billion last week:
This $74 billion decline in total assets last week was powered by a few factors. First, there was a plunge in “repo” balances. If you weren’t already familiar with the term, you might remember “repo” from late last year when the Fed pumped in trillions in liquidity to liquify the overnight lending markets that were seizing up.
Anyway, a dramatic drop in repo balances partly account for the drop in the Fed’s balance sheet.
Also contributing to the balance sheet decline were foreign central bank liquidity swaps, while some alphabet-soup programs also unwound. And the junk-bond and ETF buying program stalled.
I don’t want to get deep in the weeds on any of these things (it’s all rather technical), but they explain the $74 billion decrease in the Fed’s balance sheet. Now, in basic terms the decrease is little more than a rounding error. It only brought the Fed’s total assets down to a still breath-taking $7.095 trillion.
But there is a big shift happening right now that Wall Street doesn’t seem to understand:
The Fed has started lending to entities, including states and banks, under programs that channel funds into spending by states, municipalities, and businesses, rather than into the financial markets.
These programs include the Paycheck Protection Program Liquidity Facility ($57 billion), the Main Street Lending Program ($32 billion), and the Municipal Liquidity Facility ($16 billion).
This is not QE but more like paying businesses and municipalities, and ultimately workers/consumers, to consume. This money is circulating in the economy rather than inflating asset prices.
These types of programs are propping up consumption — not asset prices. That’s a new thing. I don’t think the hyper-inflated markets, which have soared only because the Fed poured $3 trillion into them, are ready for this shift. Again, that’s an important change and a big shift. But it’s not getting any attention.
You can see from the curve that last week’s decline in the balance sheet isn’t an accident, but part of a plan to front-load QE and then back off, rather than let it drag on for years:
Now, the Fed is still offering theoretically huge amounts of repos every day. But it has tweaked the offering terms, so that there is now almost no appetite for them, and what’s left on the balance sheet are older term repos that unwind and are gone.
The repo balances dropped by $88 billion from the prior week to $79 billion, the lowest since September 18:
Meanwhile, the Fed’s “dollar liquidity swap lines” with other central banks had been roughly flat for seven weeks, after the $400 billion surge in early April. But last week some swaps matured and were unwound, and the balance dropped by $92 billion to $352 billion.
Of that drop, $75 billion came from the swap line with the European Central Bank, $9 billion from the Bank of Japan, and $7 billion from the Bank of England (country data via the New York Fed).
With these swaps, the Fed lends newly created dollars to other central banks and takes their domestic currency as collateral. When the swap matures, the Fed gets its dollars back, and the foreign central bank gets its currency back.
This is where much of the media hype has focused on, following the endless announcements by the Fed. The Fed says that these bailout schemes are authorized under Section 13 paragraph 3 of the Federal Reserve Act, as amended by the Dodd-Frank Act. And Powell calls these creatures “thirteen-three facilities.”
Under the program, the Fed creates a Special Purpose Vehicle (SPV) as a limited liability corporation (LLC). The Treasury pads it with taxpayer equity capital. The Fed lends to the SPV with a leverage ratio of 10 to 1. Then it’s off to the races, with the SPV buying up the entire world, or so it would seem, according to the media.
The number of SPVs keeps growing. There are 10 active ones on today’s balance sheet. But in dollar terms, by the Fed standards, they’re small. After an initial burst in early April of $130 billion spread among the first three SPVs, there came a lull, and the overall balance declined. New SPVs were added, but as the balance of the first three SPVs declined, the overall balance also declined until mid-May.
Starting in late May, the new SPVs added enough so that overall balances began rising, and reached $196 billion by June 10. But last week, the overall balance ticked down by $1.6 billion:
There are now three SPVs that route funds into consumption rather than asset purchases: Again, these include the Paycheck Protection Program Liquidity Facility ($57 billion), the Main Street Lending Program ($32 billion), and the Municipal Liquidity Facility ($16 billion).
The Fed added $26 billion of Treasury securities during the week, bringing the total to $4.17 trillion. Over the past four weeks, the balance increased in a range between $9 billion in $26 billion, about the same range before the outbreak of bailout mania:
This progression of the Treasury purchases, from front-loading to tapering, is visible in the flattening curve of total Treasuries on the Fed’s balance sheet:
The Fed has cut its purchases of government-backed mortgage-backed securities (“Agency MBS”) after the initial burst. But its MBS trades take one to three months to settle, and the Fed books them after they settle, which creates an erratic pattern. So what we’re seeing today are settled trades from some time ago.
The balance of MBS rose by $83 billion to $1.92 trillion. This includes Agency Commercial Mortgage Backed Securities that the Fed started buying as part of its bailout program. But the balance of these CMBS has remained flat over the past three weeks at $9.1 billion.
For the stock market, a new phase has started. It now has to figure out how to stand on its own swollen and inflated legs in the worst economy in a lifetime, with the worst corporate earnings reports coming its way, while stock prices are ludicrously inflated.
So good luck to Wall Street.
for The Daily Reckoning