The Fed Has to Sell Treasury Holdings Back to Marketplace

The conventional wisdom by Wall Street was that the Fed would just hold onto these Treasuries until they expired off their $4.5 Trillion balance sheet largely made up of US Treasuries and Mortgage backed securities, but during the last Fed Meeting Janet Yellen talked a lot about exiting these securities off the Fed`s balance sheet, and how they are thinking and planning about this process of selling these assets back onto the market. 

This sort of news went under the radar with everyone focused on  the exact date of the first rate hike  [13], but it looks like the Fed is coming to terms with the fact that they have to sell many of these assets, especially all the treasuries, as it does no good to just let them expire on the Fed`s balance sheet, because in a sense the government at a time when their liabilities will be far more taxing in the form of the ramp up of the entitlement`s curve starting around 2018, will have to not only issue bonds and treasuries to cover these expenditures, but will then have to issue more treasuries to fund the fact that the expenditures for the treasuries issued during the Fed`s asset purchasing program (essentially government IOU`S for iou`s of T-bills and Bonds) never got funded. 

These expenditures need to be funded by an external holder other than the US Government for these Treasuries, and while Bond Yields are so low relative to historical standards it makes sense for the Fed to sell these bonds back to the market regardless if yields spike a little, versus creating additional Treasury allocations say in 2018 to cover these expenditures that never really got funded by external debt holders when interest rates are going to be much higher maybe by factors of 3 to 5 times higher in yields and financing costs.

The Government Cannot ‘Un-Spend’ the Money

There is no way the bond market will handle both [15] an entitlements funding increase in Treasury allocation and funding the IOU`S of the Treasuries that never got funded during the QE era of the Federal Reserve, it isn`t like the government didn`t spend this money already, and not go full boar Bond Vigilante like we saw in Europe in 2012.

The Fed Hurts themselves for being Overly Transparent & Risks Front Running Actions

Of course the smart thing would have been to subtly without signaling the market put some of these Treasuries back on the market when yields were so low with everyone wanting to chase yield with lots of ZIRP floating around the financial system. But that would be ‘dishonest’ and a little odd considering they are still buying treasuries (15 Billion this month), but it sure would have been the best way to exit some of these holdings, call it an administration or procedural allocation, of course the market would catch on real quick (if they were dumb enough to reveal this in a shrinking balance sheet) a little deception would be helpful here as well.

Reverse QE: Just How Big & When Will it Begin?

But it does appear that the Federal Reserve is going to sell these bonds back to the market over the next several years, so besides raising the Fed Funds Rate, investors should probably be paying attention to just how much per year the Fed is going to sell back to the market now that they are no longer buying any more bonds as QE officially winds down this month. Based upon Janet Yellen`s own words on the topic and the ramifications of just holding these assets to maturity, many on Wall Street got this one wrong. The fact that the Fed isn`t just going to hold these assets to maturity, they are actually going to sell these assets back to the market, and hope the environment both in the bond market and the overall economy are robust enough to take this process without too much of a hiccup. 

Mainstream Business Media Completely Missed The Importance of this Issue

I was surprised that the media didn`t pick up on this fact, just how much time Janet Yellen spent addressing exiting these assets off the Fed`s balance sheet during her last press conference. They are actually formulating an exit plan for these assets to slowly liquidate these holdings off their balance sheet in the coming years. The real question and problem is that QE went on in several forms for essentially 7 years, and by my conservative calculations some of these Treasuries will start expiring for the longer duration items in just 4 years.

Let the Front Running Begin in 2015

Thus 2018 being the target date just divide the number of years 4 by the number of Fed assets that they want to slowly transfer off the balance sheet, and this is the number that the Federal Reserve will be doing Reverse QE per year, and I guess per month probably starting sometime in 2015. But when you run the numbers it sure isn`t going to be $15 per month of asset sales as that only gets the Fed to $180 Billion on an annual basis, and that pace isn`t going to solve their balance sheet dilemma/problem! And based upon the dismal turnout for the last 10-Year Treasury Auction, and the fact that we have our first two Treasury Auctions of the year with no Fed Buying for the month in November and December, maybe overzealous bond investors might want to rethink that Yield Chasing Strategy for 2015.