By now it should be common knowledge that the Fed has blown up its balance sheet rather quickly to combat the current banking crisis. As the chart below illustrates, the Fed added a gargantuan sum to its balance sheet in March, netting an increase of $324B.
Figure: 1 Monthly Change by Instrument
It is important to understand what is driving the increase. The chart above buckets the increase in “Other”. A closer look at the balance sheet shows that the increase was driven by two main components under “Loans”:
- Primary Credit is a lending program available to depository institutions that are in generally sound financial condition.
- Other Credit Extension which is the value of loans made by Federal Reserve Banks that are not categorized elsewhere on [the Feds] balance sheet.
So, yes, as the Fed defines it, the balance sheet increase in March was not QE because it did not buy Treasuries. Ideally, these two different tools are short-term in nature. In fact, Primary Credit fell by $22B over the latest week. Still, though, this is not not QE and it certainly is not QT.
Speaking of QT, the Fed is still failing to reach its targets. The table below details the movement for the month:
- MBS were reduced by $25B, still short of the $32.5B target. This keeps the Fed’s streak alive of never hitting their actual MBS target
- Treasuries also saw a reduction, but only by $34.8B. This is about half the target amount
- The fall was primarily focused on the shortest end of the curve with Treasuries maturing in less than a year. It should be noted these are by far the most liquid and the easiest to sell.
Figure: 2 Balance Sheet Breakdown
The weekly activity can be seen below, where the latest week makes it look as though the crisis has passed. It’s more likely this is just the eye of the storm though. There are plenty of other weak banks that could come under pressure. The corporate real estate market could also be the next trigger for the next escalation of this crisis. When something does break next, expect another dramatic increase in the balance sheet.
Figure: 3 Fed Balance Sheet Weekly Changes
To figure out what is causing all this turmoil, look no further than the bond market. The spike in interest rates is a massive deviation from history and has exposed the cracks in a market built on cheap/easy money.
Figure: 4 Interest Rates Across Maturities
The yield curve is still inverted but has actually started to steepen some. The inverted yield curve is the clearest sign a recession is imminent, but the current steepening suggests that this crisis might look very different than 2008. Market participants could finally be pricing in the very real possibility of major stagflation.
Figure: 5 Tracking Yield Curve Inversion
The chart below shows how the yield curve has moved down slightly in the last month. The curve has dramatically changed from where it was one year ago.
Figure: 6 Tracking Yield Curve Inversion
The Fed Takes Losses
The Fed has recently accumulated about $44B in total losses. This is driven by two factors:
- Similar to SVB, it is selling assets (under QT) that are now worth less than when it bought them
- The interest paid out to banks (4%+) is greater than the interest it receives from its balance sheet (2%)
When the Fed makes money, it sends it back to the Treasury. This has netted the Treasury close to $100B a year. This can be seen below.
Figure: 7 Fed Payments to Treasury
You may notice in the chart above that 2023 is showing $0. That’s because the Fed is losing money this year. According to the Fed: The Federal Reserve Banks remit residual net earnings to the U.S. Treasury after providing for the costs of operations… Positive amounts represent the estimated weekly remittances due to U.S. Treasury. Negative amounts represent the cumulative deferred asset position … deferred asset is the amount of net earnings that the Federal Reserve Banks need to realize before remittances to the U.S. Treasury resume.
Basically, when the Fed makes money, it gives it to the Treasury. When it loses money, it keeps a negative balance by printing the difference. That negative balance has just exceeded $44B!
Figure: 8 Remittances or Negative Balance
Note: these charts are a correction to earlier articles that aggregated the Fed’s negative balance, overstating the losses.
Who Will Fill the Gap?
With the Fed out of the treasury market, who will fill the massive 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. There has been a modest increase in recent months up to $7.4T, but total foreign holders have not eclipsed the high seen back in Nov 2021 of $7.7T. This means the total foreign holdings of US debt have been flat or down for almost 18 months.
Note: data was last published for January
Figure: 9 International Holders
The table below shows how debt holding has changed since 2015 across different borrowers. Total Chinese holdings have now fallen to $860B, the lowest since at least 2015.
Figure: 10 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. The latest shrinking of the balance sheet lasted 12 months before the recent spike. The Fed is arguing that these measures are temporary but even so, QT has definitely slowed and the balance sheet has expanded rapidly in March.
Figure: 11 Historical Fed Balance Sheet
Well, the Fed finally broke something, but Powell seemed adamant about downplaying this fact in his latest press conference. The expansion of the balance sheet certainly indicates otherwise. The Fed is trying to buy time for the banks with its latest measure, but the system is breaking because of the very actions of the Fed. The economy is addicted to cheap and easy money, so any removal of monetary easing will be met with problems.
The falling money supply is certainly showing that trouble is brewing. Sure, the Fed just injected $300B in fresh money, but that will not be enough to keep this bubble from popping. The Fed will have to do more if it wants to keep things from falling apart.
Powell is still talking tough, but that bluff is harder to sell based on the response to the collapse of SVB and Signature Bank. The Fed could not have folded faster or harder than it did three weeks ago. The first sign of trouble and the Fed unloads cheap money to keep things afloat. People need to take notice and see that this response, more than anything else, proves the Fed is totally bluffing and has no stomach for actual economic pain.
If it isn’t obvious yet, it will be in time. At that point, gold and silver will be much higher. It’s best to load up while prices are still below all-time highs.
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: Mar 29, 2023
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