What Taper? Fed Adds $126B in November
The Fed added $82B in Mortgage-Backed Securities (MBS) and $65B in Treasuries while allowing $22B in Repo agreements to roll off the balance sheet. The net gain is $126B in the month that the “Taper” was set to begin.
The Fed autopilot buying targets about $120B in monthly purchases split by $40B in MBS and $80B in US Treasuries. The stated objective is to decrease purchases by $10B per month in Treasuries and $5B per month in MBS. This means the Fed should have bought around $70B in Treasuries and $35B in MBS. Based on the latest data, the Fed is ahead of schedule in Treasuries but missed the mark on MBS by over 100%.
To be fair, the weekly data on MBS is a bit more sporadic (see Figure 5 below). The MBS maturity schedule is bulky and occurs once a month. This month, there was no big roll-off of MBS which is what caused such a large discrepancy. That being said, given how much the Fed publicized the onset of “The Taper”, it seems odd they weren’t more accurate with their targeting. Perhaps next month shows a larger decrease in purchases.
Figure: 1 Monthly Change by Instrument
As discussed last month, the Fed had failed to hit the $120B target for three months in a row. Interest rates had been rising during the entire period the Fed had been underweight in purchases. While a few billion wouldn’t impact interest rates on the multi-trillion-dollar treasury market, it could be argued the market was reading into the Fed appetite for bonds, and responding accordingly.
This month saw another large increase in interest rates. Again, there is no way this is attributable to the Fed lowering Treasury purchases by $15B, but it is entirely possible the market is responding to the largest buyer pulling back from the market.
The data has not yet been updated to reflect the massive drop in interest rates experienced on Friday. Rates went back to where they were on Sept 24 in a single trading session. This can be attributable to fears associated with a new Covid variant. Therefore, the chart below accurately reflects the market pricing given the circumstances laid out by the Fed activities and not market uncertainty due to Covid.
Figure: 2 Interest Rates Across Maturities
The table below shows the breakdown of holdings by instrument and the period over period change as indicated. The main takeaways:
- The Fed added significantly more 10+ year and < 1-year debt than the 12-month average
- < 1-year annual avg is $5B a month vs $16B added last month
- 10+ year annual avg is $25B a month vs $30B added last month
- 1-5 year and 5-10 year saw the opposite moves
- 1-5 year annual avg is $35B a month, but only $16B was added
- 5-10 year annual avg is $15B a month, but only $2.5B was added
Figure: 3 Balance Sheet Breakdown
It’s hard to know how the Fed determines what to buy each month. It typically goes for the center of the yield curve in 2-10 year debt but decided to go for the tails during November. Can this explain the massive run-up in rates in November? Again, maybe, if the market is tracking and responding to this data. If the Fed is having a more direct impact on rates, then this is a very bad sign of what the market can bear.
If fears over the new Covid strain are overblown and rates resume climbing next week, then the Fed and Treasury are both in trouble. As illustrated in the debt analysis, every .25% increase on Bills costs the Treasury $10B within 6 months but will increase the cost of Notes by $31.6B once it works through the maturity curve (avg maturity 3.4 years). That means a 1% increase in rates will cost the Treasury an extra $200B per year once it gets priced in.
Pretend for a moment the Fed fights inflation and raises rates by 5% points. A conservative estimate given the current 6% CPI. The result would be $1T more in interest payments per year! It’s simply not possible.
The Fed cannot fight inflation, and if “The Taper” drives up rates, which appears to be happening, then the game is over.
The chart below shows the relative (percent) distribution by product. While absolute values have increased quite significantly as shown in the table above, the distribution of holdings has only changed some. MBS made up 40% of the balance sheet 3 years ago, but the number has fallen to 30%, up from 27% a year ago. Short-term (1-5 year) and medium-term (5-10 year) sit at 24.5% and 11.6%. These numbers continue to move up each month as the Fed presses on the center of the yield curve.
Figure: 4 Total Debt Outstanding
Zooming into weekly
Another chart to look at is the weekly change in the balance sheet. As mentioned above, the MBS activity this month deviated from the normal pace of turnover.
- A series of MBS Mature about every four weeks
- This usually results in a slight decrease in the balance sheet for that week. This did not occur this month on the 4th week.
- Treasury purchases this week were also lower than average. Is this “The Taper” or a holiday week?
Figure: 5 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 latest week shows a significant drop in accumulation relative to the averages.
Figure: 6 Average Weekly Change in the Balance Sheet
The Fed is clearly monetizing US Debt. The chart below uses 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 by the Treasury in each of the last 4 years by instrument. This shows very clearly how the Treasury has been rolling short-term debt to long-term debt in 2021.
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 33% and 46% respectively, up slightly from last month.
Who is going to absorb all this debt issuance if the Fed tapers? Who can absorb almost half of the long-term debt the Treasury will be issuing for the foreseeable future? This is why the Fed will be so delicate with tapering and inevitably increase it as spending in Washington continues unabated!
Figure: 7 Debt Issuance by Year and Instrument
Figure: 8 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. The Fed already has $9T in its sights.
Figure: 9 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 is attempting to Taper, but the math is working against them. They will inevitably reverse course and begin expanding their balance sheet by more than $120B a month. This 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.
Ignore the short-term fluctuations. The market is pricing in an aggressive Fed. Nothing could be further from the truth if you trust the math and the data. Real interest rates will remain negative for the foreseeable future.
Data Updated: Weekly, Thursday at 4:30 PM Eastern
Last Updated: Nov 24, 2021
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