Submitted by Peter Tchir of TF Market Advisors,
What the Fed Owns
As we head towards NFP and discussion about tapering picks up again it is time for our Fed balance sheet report. At least in terms of the treasuries they own as they continue their Hunt Brothers impersonation.
We ignore TIPS which add another $867 Billion, not because they aren’t important, but because I haven’t figured out an easy way to calculate the proper notional amounts or coupons with all the inflation adjustments. The Fed has been buying those as well, so it doesn’t distort the percentages that much.
We include T-bills which are up to $1.7 trillion. Ignoring T-bills takes the Fed’s ownership up from 18.8% to 22.4%.
The Fed now owns 48.6% of every bond maturing between 10 and 15 years. That all important part of the curve now has a “free float” of $65 billion bonds. Assuming some amount of that is tucked away in pension funds and not available for sale and the Fed could buy up all the remaining bonds in that sector with just one month’s worth of QE.
The 15 to 20 year part of the curve could be mopped up in less than 2 weeks of QE.
There are now 8 issues that the Fed owns 70% of which is the maximum that it is allowed to own.
There are 63 issues where the Fed owns at least 50% of the issue. There are 123 treasury bonds with maturities of 2018 or later. The Fed owns more than 50% of 59 of those issues.
It really is only the new issues that have a low Fed holding and are truly free to trade.
The Fed continues to take up the supply of any bond that pays a coupon.
The Fed’s bond portfolio has an average coupon of 3.4% leaving an average coupon of 1.9% for the rest of us (I ignore T-bills for these calculations).
The Fed has a long duration, high dollar price, high coupon portfolio.
Back at the end of September the Fed’s average price was 107.76. That has decreased by 0.5%. Some of that could be because they bought low price bonds, bringing the average down, but the rest will be pull to par effect and moves in rates. Good thing the $10 billion isn’t marked to market.
While the Fed “only” owns 18.8% of the entire treasury market, they get 33.6% of all coupon paid.
So Treasury pays out all this interest ($207 billion annually) and gets back $70 billion less some costs associated with running the Fed.
So over the past two months, including mark to market, the Fed should have made about $4 billion. If Yellen can figure out a way to get paid 2 and 20 on that, it could be a really nice gig.
What Does Any of This Mean?
It means that the Fed is still one of the biggest positive line items in the budget and the QE just enables D.C. to do less than it would otherwise.
It means that we continue to play in a market where one player dominates so much of the supply that D.C. would be howling with indignation about manipulation if it was happening in any other market. Instead backs are getting sore from all the patting.
It means that the Fed is probably going to have to tone down purchases or move more aggressively to the front of the curve.
It means that I would be very nervous about being short treasuries here because in addition to steep curves and low inflation, you have the potential for a short squeeze as the free float of longer bonds is just small.