What has been expected for quite a while has now officially happened. The Federal Reserve stated that it would stop intervening on the market where it has been buying treasury bonds and mortgage-backed securities like there was no tomorrow anymore. The program started at a rate of $45B per month but was upscaled rather fast to $85B per month before being gradually scaled back since the beginning of this year. The Fed’s balance sheet has expanded considerably as you can see on the next chart.
Whereas the total balance sheet of the Fed was less than 1 trillion Dollars by the end of 2008, this has been increasing exponentially and in just the last 24 months the assets on the Fed’s balance sheet increased by 60% to 4.5 trillion dollars. Yellen has kept her promise as she said she’d scale the open-market purchases back if the economy would strengthen sooner than anticipated. Even though Quantitative Easing has now officially been stopped, the reaction in the gold price was actually quite muted. Gold bears have been predicting a crash of the gold price as soon as the money-printing stage would be reduced or stopped, but they have been proven wrong as the gold price dropped less than 2.5% on the news and subsequently lost another 3%.
This means that gold is much more resilient than originally thought and that the gold price is NOT purely depending on the effects of a Quantitative Easing program, as so many people want to make you believe. But wait, let’s not get carried away by the so-called ‘End of Quantitative Easing’ and have a closer look at this MBS purchase program. The Fed’s announcement to stop purchasing additional Mortgage-Backed Securities was just talking about NEW investments paid for by freshly printed money. It is the central bank’s intention to continue to reinvest the returns on its $1.7 trillion dollar Mortgage-Backed Securities portfolio back in the market in the foreseeable future.
If we’d estimate the return on investment on these MBS’es to be 2.75% (which is roughly the return in the PIMCO MBS Fund where the average maturity of the MBS portfolio is less than 4 years), an additional $47B (on TOP of the maturing principal amounts) per year which would flow into the Fed’s treasury will very likely immediately be reinvested. That would mean that on average $4B per month in interest payments would continued to be invested in MBS, and this is just a 20% decrease versus the official $5B per month number. So even though the Federal Reserve pretends it will no longer spend $5B per month on mortgage-backed security purchases, it isn’t actually stopping the MBS purchases as these will continue at at least $4B per month. This number will very likely be even higher, as it is also the Federal Reserve’s intent to reinvest the principal amounts as well. So in the MBS market, the Federal Reserve is saying one thing but is actually doing the complete opposite.
The only difference is that these aren’t called ‘MBS purchases’ but ‘reinvestments’. Whatever they want to call it, the Federal Reserve will still pump in excess of $45B per year in the MBS market so the life support will still be switched on in the foreseeable future. And the Federal Reserve has no official mandate to take the money back out of the market when the MBS mature. Theoretically, the central bank would be allowed to reinvest the principal amounts as well as the interest payments on these amounts in infinity. Even though market analysts at for instance Deutsche Bank expect the Fed to phase these investments out by 2017, the central bank is under no real obligation to do so. The next chart shows you that the Federal Reserve has been doing this for a while. At the previous meeting of the FOMC, the Federal Reserve announced it would scale back the purchase of Mortgage-Backed Securities to just $5B per month. One would then expect the total amount of MBS on the Fed’s balance sheet to increase by roughly $5B. Caught in the act, the official numbers show you that in just one month the total amount of MBS increased by not less than $16B.
The real ‘credibility test’ for the Federal Reserve will no longer be in the official Quantitative Easing numbers but in the size of the balance sheet. We dare to bet the balance sheet of the Federal Reserve won’t shrink at all in the near future, and we expect the total balance sheet to remain at extremely elevated levels for the foreseeable future. The official Quantitative Easing has ended, but the Federal Reserve isn’t stopping its interventions as the MBS purchases will continue at the same pace. It only wants you to believe it did.
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