The Fed came close but still fell short of its $95B a month target. This means the Fed has fallen short in 8 of the last 9 months.
While the roll-off of Treasuries seems to be going as planned, the Fed has been completely unable to unload MBS. The current target is $35B a month, but the Fed has been nowhere near that amount. In the latest month, only $4.5B in MBS rolled off the balance sheet.
Figure: 1 Monthly Change by Instrument
The table below details the movement for the month:
- The Fed was clearly focused on the short end of the curve, perhaps hoping to not push up long rates too much
- The Fed surpassed the $60B target in Treasuries
- Other added to the reduction by $12.6B, but this was still not enough to hit the $95B target
Figure: 2 Balance Sheet Breakdown
Looking at the weekly data shows that activity has been more sporadic in the last two weeks in Treasuries. Activity in MBS has been almost non-existent.
Figure: 3 Fed Balance Sheet Weekly Changes
As the Fed continues to miss on the MBS reduction, the overall portfolio allocation of MBS has grown. MBS now makes up 31.3% of the balance sheet. Also, surprising is the surge in 10+ year maturity. Is the Fed quietly relaunching operation twist to contain the long end of the curve?
Figure: 4 Total Debt Outstanding
Operation Twist would seem unnecessary given the inversion in the yield curve. Then again, the entire yield curve has become a jumbled mess, so maybe the Fed just doesn’t know what to do at this point. The recent spike in yields has brought the 10-year back towards 4% while the 2-year approaches 4.7%.
Figure: 5 Interest Rates Across Maturities
The yield curve inversion between 10 and 2-year notes reached -83bps on Feb 14th, matching the low seen back on December 7th.
Figure: 6 Tracking Yield Curve Inversion
The chart below shows how the yield curve has moved up over the last month. The curve compared to 1 year ago is quite dramatic!
Figure: 7 Tracking Yield Curve Inversion
A lost Revenue Source for the Treasury
With the Fed now dealing with higher rates and liquidating its balance sheet, the losses are really starting to pile up. The Fed lost $126B in February. For perspective, the largest yearly gain over the last 10 years came in 2021 with a gain of $104B. Yes! You read that correctly, the Fed is now losing more in a month than it was earning for an entire year!
According to Reuters, the Fed has been warning about this possibility for some time. That doesn’t change that these are massive losses! It should be noted, the Fed will not send the Treasury a bill to cover its losses. Instead, it will book the losses into a deficit account that will be held until the Fed makes enough money to make up for its losses.
Figure: 8 Fed Payments to Treasury
The chart below shows the yearly losses. Keep in mind that 2023 only includes January and February. At this pace, the Fed will lose well over $1T in 2023!
Figure: 9 Fed Payments to Treasury
Who Will Fill the Gap?
Bloomberg recently published an article that shows how the typical Treasury buyers have all stepped back from the market. First and foremost, this includes the Fed which has been the biggest buyer in the market for years. It also includes institutional investors and foreign countries.
As shown below, the international holders have lost interest in the Treasury market. The latest month saw a slight uptick in December but is $500B below the high from 2022. It’s a good thing the Treasury is dealing with the debt ceiling right now and not issuing new debt… there seem to not be many buyers out there!
Note: data was last published in December
Figure: 10 International Holders
The table below shows how debt holding has changed since 2015 across different borrowers. China is now well below $1T while Japan has pulled back to the lowest level since 2018.
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 last balance sheet reduction lasted almost two years in 2017-2019 but was smaller in magnitude. Even though the current reduction continues to miss target, there is still enough tightening to shrink the money supply. The Fed will likely not get two years into their reduction on this go-around. It only took about 12 months for the Fed to trigger the panic in Q4 2018. The panic this time around will be far worse.
Figure: 12 Historical Fed Balance Sheet
What it means for Gold and Silver
The Fed keeps on moving forward, seemingly oblivious to the potential catastrophe they are creating. Clearly, they are aware of trouble in the Mortgage market or else they would be more focused on actually meeting the target they set for themselves.
In either case, the Fed has a bloated balance sheet and there is zero chance they are able to shrink it down to anything remotely normal. The Fed also has a new problem on its hands as it loses hundreds of billions of dollars each month. This would be a death sentence for any organization that couldn’t print money at will.
And thus, the Fed will have to go back to printing. The economy needs it, the Treasury needs it, and the Fed needs it. Trouble takes time to manifest. The only difference this time will be that when trouble strikes, it will likely be an absolute disaster. In this scenario, having some wealth outside the banking system will be an excellent insurance policy!
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: Feb 22, 2023
Interactive charts and graphs can always be found on the Exploring Finance dashboard: https://exploringfinance.shinyapps.io/USDebt/
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