At its May meeting, the Fed announced the beginning of its program to shrink its balance sheet. That program is colloquially known as QT or Quantitative Tightening. It will begin with reductions of $30 billion per month in its Treasury holdings, and $17.5 billion per month in its MBS holdings. That will last through August. Then in September it plans to go to $60 billion per month in reductions of Treasuries, and $35 billion in reductions of MBS.
For comparison, under Janet Yellen’s attempt to shrink the Fed’s balance sheet in 2017-2019, the peak monthly reduction was $30 billion per month in Treasuries, and $20 billion in MBS.
That resulted in plenty of havoc in the markets, and Powell was forced to abandon the process in 2019.
This new attempt is a big deal, because through this program, the Fed will actually pull money out of the banking system at a time when the system is already under duress. Inflation is raging, and bond prices have been plummeting, and yields surging, for 22 months. Banks have hidden losses on their books from that. Those losses will start to be recognized as the Fed puts additional pressure on the system.
Stocks have also been cratering. Financial markets are likely to become even weaker than we have already seen as the Fed embarks on this additional level of tightening. As stock and leveraged bond portfolios decline in value, there will be margin calls. And that will exacerbate the situation.
Not only will the Fed now not be the biggest buyer of Treasuries in the market, it will force the US Treasury to issue even more supply. By demanding that the Treasury repay a portion of the money that the Fed lent it via its purchases of Treasury securities, the Fed will force the Treasury to sell more debt to the public to raise the cash to repay the Fed. That cash will then be extinguished. It will leave the banking system and be gone. Poof. Just like that.
At the same time the Treasury will continue to need cash to fund its regular outlays.
Recently, the TBAC (Treasury Borrowing Advisory Committee) has raised its forecast for tax revenue and lowered its estimate of Treasury supply. As usual with economic forecasts, they are backward looking and ignore current, actual conditions. The booming tax revenue trend that we saw beginning over a year ago is already showing signs of weakness in the economic component that is hidden by the inflation component. If revenues are not up to expectations, Treasury supply will increase beyond the modest levels that the TBAC expects. But even those levels are sufficient to pressure the markets.
The money to repay the Treasury’s debt to the Fed will have to come from somewhere, and that somewhere will be investors, banks, and dealers. They’ll need to liquidate other securities, and other assets of all kinds.
This report will show you in charts and clear discussion, how we got here, where we are, exactly where the markets are headed, and what you can do about it to protect your assets, and even grow your capital in the dangerous, even deadly, months ahead. Non-subscribers, click here for access.
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