Barclays' Joseph Abate Muses: It's Not The Size Of QE2, It's How You Use It

Tyler Durden's picture

In advance of today's FOMC statement which the entire market is waiting for with bated breath, specifically focusing on just what form any incremental quantitative easing will take (if any), Barclays' Joseph Abate once again steps back to observe the forest in avoidance of the trees, and asks the critical question: just what is the objective of this round of QE: is it to force down short- or long-term interest rates. And since the economic benefit of the former is minuscule, the Fed will arguable be focused on the latter, thus forcing Abate to ask how this can be best accomplished "without causing the disruptions that cropped up in the first round of asset purchases." The Barclays strategist also wonders if the purpose of a possible MBS monthly purchases on a periodic basis, rather than en masse, is merely to prevent a problem that has recently become prevalent: namely the surge in MBS trade fails, a phenomenon that has received surprisingly little attention lately, yet which as the chart below from Mortgage News Daily shows is become quite a major problem, and one which the Fed is certainly concerned about (and if it isn't it should be). In other words, most pundits openly ignore the very likely distortions that will arise from a wholesale attempt at pushing LT rates lower. Read on for Abate's open ended question, as well as his logic as to why possible QE forms, at least as presented by the general media, are likely to be woefully insufficient. 

From Joseph Abate:


In thinking about another round of quantitative easing, the Fed would have to work through a few issues. First, it needs to decide what the objective is – is it to drive down short- or long-term interest rates? Second, if the goal is to pull down long-term rates – which would produce the most economic stimulus – how can this be accomplished without causing the disruptions that cropped up in the first round of asset purchases?

Given the current level of short-term interest rates, we think any additional stimulus designed to pull the funds rate, repo or bill yields lower by increasing reserve balances at banks would likely be quite small. First, the relationship between the overnight funds rate and the level of bank reserves has broken down. Not only are banks structurally long cash, but, volumes traded in the funds market have shrunk substantially, with only the GSEs as the biggest players. Thus, there is no need to target a specific level of bank reserves – it matters little to short rates whether the level of bank reserves stays at $1.050trn, goes higher, of falls by $200bn through year-end, as we expect. Second, we think there are more effective ways to pull short rates lower – either by cutting the IOER or by allowing the SFB program to expire. Both could drag short rates down without being tied to a reserve operation of a specific size.

Since short rates and reserve balances have become unmoored, and the stimulative effect of pushing these rates down another 10-15bp would be low, any additional QE from the Fed would mostly likely focus on bringing down long-term interest rates, where it could get more “bang for its buck”.

The Fed would then be resurrecting a key FOMC debate from 2009 – what matters more for long-term interest rates: the size of the Fed’s asset (MBS) holdings or the pace of their acquisition? If the size of the portfolio matters most, then the only reason to purchase MBS securities at a monthly rate rather than in rapid-fire succession might be to prevent the disruption its earlier purchases created by causing fails (or incomplete deliveries) to spike. Alternatively, the Fed could simply buy Treasuries where its purchases would be less likely to cause significant distortions. Regardless, re-engaging QE – even in the light version to keep the Fed’s balance sheet steady – may require a bit more thought than simply flicking a switch.

QE ‘lite’

Markets have begun pricing in a small probability of some kind of Fed action by year-end with 3m OIS slipping 2bp to 17bp in the past month. At the same time, the December FF contract is very slightly inverted to the September contract. Discussions about what the Fed might do to prevent additional softening have focused on a QE ‘lite’ strategy of MBS (or Treasury) purchases to offset the shrinkage in the Fed’s balance sheet caused by prepayment roll offs. Our economists do not believe that growth will become sufficiently soft to justify another round of quantitative easing. Since the start of the year, reserve balances have remained fairly steady at 1.050trn (as of Wednesday, $1.038trn). More significantly, the Fed’s MBS portfolio, which peaked 3 weeks ago, is only $12bn lower.

Looking ahead to year-end, our mortgage strategists believe that at prevailing interest rates the Fed could see an additional $115bn in prepayments ($275bn annualized). Since prepayments shrink the size of the Fed’s portfolio, they permanently reduce the level of reserves in the banking system. Other components of the Fed balance sheet should also lead to a permanent shrinkage in reserves, including maturing Agency debt securities and the secular increase in currency in circulation. Adding in temporary swings in the Treasury and GSE cash deposits at the central bank, we look for aggregate reserve balances to shrink by almost $200bn by December, ending the year at $875bn. Thus, the QE ‘lite’ proposal being discussed in the press would have the Fed in the market buying approximately $23bn in either Treasuries or MBS each month – just to keep the Fed’s MBS portfolio from shrinking.

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LoneStarHog's picture
It's Not The Size Of QE2, It's How You Use It -- Oh Boy! -- Another MCC, "Faster, Deeper, Harder".
rapunzel's picture

be F O R E  warned, i suppose.


Chartist's picture

All I know is the FXY is lower today.....I think someone is buying this selloff and I suspect we'll see a higher market this week.

DavidC's picture

What sell off? The Dow is still around the 10,600 level and FTSE still between 5350 and 5400. I'll call it the start of the sell off when the FTSE is below 5300 and the Dow below 10,500.


Traianus Augustus's picture

And not one mention of KY usage!!!

Amsterdammer's picture

This from a Credit Suisse's analyst: "QE works via five routes:

* (1) It pushes up asset prices (holders of government bonds or other bonds have cash and are forced to make an asset allocation decision in an environment where real bond yields are artificially low). Indeed, Charlie Bean, Bank of England Deputy Governor, highlighted that this was the key rationale behind the MPC’s QE in 2009.

* (2) The rise in asset prices has a wealth effect on the consumer and corporates (it becomes more expensive for corporates to buy, so they build!);

* (3) Lower real bond yields/ credit spreads help to improve housing affordability;

* (4) Low bond yields give governments more discretion on fiscal policy and might encourage a looser fiscal policy (as otherwise they might be forced into premature tightening by high and rising bond yields)-it is worth noting that in the last 3 weeks the US have de facto eased fiscal policy slightly as a result of lower bond yields (we saw $32bn of further unemployment benefit being renewed and more recently $26bn of help to states/local governments);

* (5) Weaker currency. A weaker dollar in effect will export US monetary policy (if the Yen were to for example strengthen dramatically further, then the BoJ would probably resort to more aggressive QE).

SteveNYC's picture

We should focus the entire US economy on this wonderful phenomenon, "the printing of money". Heck, with all these benefits, it seems to me that's pretty much all we'll need to do forever more!

Perhaps we can even export this amazing phenomenon, sell it as part of our "service" economy?

This CS guy should be shot......

lizzy36's picture

If size doesn`t matter why are there no 3 inch dildos?

The Rock's picture

LOL. ... Just 3in pricks.

Miles Kendig's picture

Luck of the Irish is en Vogue at Barclay's... and wow..  glass with no bowl and it can still smoke some

rapunzel's picture

miles miles miles.

never knew. and to think my master glass teacher wouldn't let me blow glass bongs, he sure of hell, never mentioned this sort of object to blow. i wonder how it works, like a finger?

Miles Kendig's picture

naw  It's the six tongue tips on the end rotated at the direction of the user via the channel created by the guide n slide dots near the center.  Looks like this could not only push a button, but flip tease the immediate environs at the same time..  an essential skill set for all aspiring jungle boys and/or girls to learn from their sponsoring cougar/s.

No wonder there are all sorts of low rider chicks out there...

rapunzel's picture

miles, your going to have to show me.

Miles Kendig's picture

3.1, how six can be better than two or that being Irish is more than it's cracked up to be?

rapunzel's picture

still don't get it. maybe, the irish thing.

Miles Kendig's picture

hmm   It seems you get the rest which is sufficient for the moment.  peace  and thanks for adding your commentary to the mix.

ussa's picture

The should just send a  $30k check to every US citizen.  It would have more effect than any of the worthless QE that has occurred.  At least the inflation would be somewhat fair to Americans.

Tense INDIAN's picture

HOW TO FIX the economy.......this is what i read in sometime lastv year....

they have spent TRILLIONS in Bailout.....its amazing to see that it can be done with a few millions....


There are about 40 million people over 50 in the work force. Pay them $1 million apiece severance for early retirement with the following stipulations:
1) They MUST retire. Forty million job openings - Unemployment fixed.
2) They MUST buy a new American CAR. Forty million cars ordered ­ Auto Industry fixed.
3) They MUST either buy a house or pay off their mortgage ­ Housing Crisis fixed.
It can't get any easier than that.
P.S. If more money is needed, have all members in Congress pay their taxes...
Mr. President, while you're at it, make Congress retire on Social Security and Medicare. I'll bet both programs would be fixed pronto.
this also shows how DUMB the population have become ...they cant fathom BILLIONS millions TRillions....n what can be done with these amounts
MachoMan's picture

Or plan B, tell them a part of their monthly check isn't coming because you're cutting back...  everyone is cutting back...  if the economy grows, they might get more...  if not, better luck next time.  But we're paying our international treasury holders 100 cents on the dollar. 

PS, that's $40t....  which would cause holyfuckinstacollapse.

Internet Tough Guy's picture

Pull down long rates? But banks like steep curves, not deflation.

The Rock's picture

Size does matter. As one black woman put it, "I don't want no tugboat in my harbor, I want a luxury liner!"

rapunzel's picture

Goldilocks once said, just enough is best.


Miles Kendig's picture

Disruptions!?  Bad air and bloodletting usually lead to all that.

Eduardo's picture

... and Bernanke. Do not show your QE after being in a swimming pool because it shrinks!