The Fed Balance Sheet Unwind Myth

Authored by Lance Roberts via,

Since the beginning of the year, the Federal Reserve has been heavily discussing, warning rather, they were going to begin to “unwind” their gargantuan balance sheet. As Michael Lebowitz recently penned in his subscription-only article “Draining The Punchbowl:”

“Since QE was first introduced, the S&P 500 has gained 1,546 points. All but 355 points were achieved during periods of QE. Of those remaining 355 points, over 80% occurred after Trump’s victory.”

That is a pretty amazing set of stats. I have previously noted the high correlation of the financial markets relative to the ongoing liquidity operations of the Federal Reserve. I have updated that analysis to show the reduction in the balance according to the Fed’s proposed schedule.

While the market stumbled following the end of QE in the United States, global QE, as shown in the charts of the major global Central Banks picked up the slack.

But now, the ECB has already begun discussing their plans to begin cutting the amount of their QE program by half in the coming year.

“European Central Bank officials are considering cutting their monthly bond buying by at least half starting in January and keeping their program active for at least nine months, according to officials familiar with the debate.


Reducing quantitative easing to 30 billion euros ($36 billion) a month from the current pace of 60 billion euros is a feasible option, said the officials, who asked not to be identified because the deliberations are private. That reduced flow would match existing predictions from economists at institutions including ABN Amro Bank NV and Bank of America Merrill Lynch.”

The hope, of course, by Central Bank officials is that global economies are now humming along at a pace strong enough to withstand the reduction of “emergency measures.” Of course, the real question is whether the Central Bank’s “measures” of economic strength are accurate. While there are certainly indicators such as GDP growth, production, and employment measures which suggests that global economies are indeed on a cyclical upswing, there are also numerous measures which suggest the opposite.

As I stated previously,

“The Fed understands that economic cycles do not last forever, and we are closer to the next recession than not. While raising rates will accelerate a potential recession and a significant market correction, from the Fed’s perspective it might be the ‘lesser of two evils.’ Being caught near the ‘zero bound’ at the onset of a recession leaves few options for the Federal Reserve to stabilize an economic decline.”

With the Fed trying to raise interest rates, and reduce the balance sheet simultaneously, the “tightening of monetary policy” is a drag on economic growth and ultimately the stock market. But as I stated above, while the Fed is currently “discussing” the reduction of their balance sheet beginning in October, they actually haven’t. In fact, just last week the Fed increased their balance sheet by over $13.5 billion dollars. No wonder the stock market shot higher. 

Since these balance sheet expansions generally have occurred at points where asset prices were at risk due to some “event,” the latest expansion occurred during the “tax cut hope” driven rise. The raises the potential question of:

“What does the Fed know that we don’t.” 

Wolf Richter recently proposed 5-possible conclusions to extract from the Fed’s actions:

  1. The whole QE-unwind announcement was a hoax to test how stupid everyone is. But I doubt this.
  2. The people running the OMO are on vacation and have been replaced by algos or interns, and they just keep doing what the folks now on vacation have been doing for years. I doubt this too.
  3. The FOMC told the public what it wants to have done but forgot to tell its own people at the Trading Desk. I doubt that too.
  4. There is willfulness in it – a sign that they’re not ready, or that they want to give the markets more time to get used to the idea of it, etc. And this could be the case.
  5. They’re seeing something that worries them, and they’re holding off for now to get a clearer picture. But I doubt this because their decision to commence the QE-unwind on October 1 was unanimous, and since then nothing of enough enormity has changed.

While Wolf doubts the 5th point. I don’t as much. The reason I say that is because the yield curve seems to be sniffing out something.

Given current market valuations, exceedingly low yields on junk bonds globally, complacency elevated along with very high levels of both bullish sentiment and heavy investor equity allocations, the risk of a “policy related” error is extremely high.

The “Bond Bull” Ain’t Dead…It’s Just Resting

The recent “pop” in rates, after declining to near 2% this summer, has once again brought calls for the end of the “bond bull.” These calls have been, for the last 4-years, prime buying opportunities to add bond exposure to portfolios. The recent rise in rates came with the election of President Trump and hopes for “tax cuts and reforms.” Theoretically, these policies will boost economic growth and inflation as seen during the Reagan era leading to higher rates for bonds. However, as discussed previously, given the completely inverted state of economic dynamics, there is a high probability these reforms will fail to create the economic growth boost currently hoped for. (That is even if they come to fruition.)

But the Fed’s balance sheet reduction is also suggestive of lower, not higher, interest rates. In the past, despite what the Fed suggested would happen, rates rose during their QE programs as money rotated out of the “safety of bonds” back into equities. When those programs ended, rates fell. Rates also fell to lows after the end of QE, and despite the “Trump Bump” since the election, the further reduction of liquidity, and potential onset of a recession in the months ahead, will likely lead to a significant push lower as money rotates from “risk” back to the “safety” of U.S. Treasuries.

As I laid out previously:

“There is an assumption that because interest rates are low, that the bond bull market has come to its inevitable conclusion. The problem with this assumption is three-fold:


  1. All interest rates are relative. With more than $10-Trillion in debt globally sporting negative interest rates, the assumption that rates in the U.S. are about to spike higher is likely wrong. Higher yields in U.S. debt attracts flows of capital from countries with negative yields which push rates lower in the U.S. Given the current push by Central Banks globally to suppress interest rates to keep nascent economic growth going, an eventual zero-yield on U.S. debt is not unrealistic.
  2. The coming budget deficit balloon. Given the lack of fiscal policy controls in Washington, and promises of continued largesse in the future, the budget deficit is set to swell back to $1 Trillion or more in the coming years. This will require more government bond issuance to fund future expenditures which will be magnified during the next recessionary spat as tax revenue falls.
  3. Central Banks will continue to be a buyer of bonds to maintain the current status quo, but will become more aggressive buyers during the next recession. The next QE program by the Fed to offset the next economic recession will likely be $2-4 Trillion which will push the 10-year yield towards zero.”


In this past weekend’s missive “Yellen Speaks Japanese” and yesterday’s post “Debt, Deficits & Economic Warnings” I laid out the data constructs behind the points above.

With Yellen pushing the idea of more government spending, the budget deficit already expanding and economic growth running well below expectations, the demand for bonds will continue to grow. However, from a technical perspective, the trend of interest rates already suggest a rate of zero during the next economic recession.”

Here is the point, while the punditry continues to push a narrative that “stocks are the only game in town,” this will likely turn out to be poor advice. But such is the nature of a media-driven analysis with a lack of historical experience or perspective.

From many perspectives, the real risk of the heavy equity exposure in portfolios is outweighed by the potential for further reward. The realization of “risk,” when it occurs, will lead to a rapid unwinding of the markets pushing volatility higher and bond yields lower. This is why I continue to acquire bonds on rallies in the markets, which suppresses bond prices, to increase portfolio income and hedge against a future market dislocation.

In other words, I get paid to hedge risk, lower portfolio volatility and protect capital. Bonds aren’t dead, in fact, they are likely going to be your best investment in the not too distant future.

In the short-term, the market could surely rise further, especially if the Fed continues reinvesting the proceeds from their balance sheet. This is a point I will not argue as investors are historically prone to chase returns until the very end. But over the intermediate to longer-term time frame, the consequences are entirely negative.

As my mom used to say:

“It’s all fun and games until someone gets their eye put out.”


fx Pinto Currency Thu, 10/26/2017 - 18:23 Permalink

It's beyond me how seemingly smart people still try to align macro data with FED actions - despite the fact that the so-called data-dependent FED policy has long been exposed as a plain lie. The only data that matter to the FED are the SP500 and the debt clock of the economy. Both forbid any meaningful rate normalization , till eternity. There is a reason why the market refuses to believe in the FED's interest rate dots...

In reply to by Pinto Currency

earleflorida Thu, 10/26/2017 - 13:39 Permalink

funny how the pirates would dig a hole at low tide and put their captured in it, with their victims graves only deep enough as to expose their heads for the inevitable 'high tide, as they watched with glee as nought a drop of bood nor a bullet was spared...---counting their treasur[ed] gold!

taketheredpill Thu, 10/26/2017 - 13:41 Permalink

  This is what I don't get.  Looking at the Rates chart (last chart), when QE starts, Stocks Trade Up, Bonds Sell Off and when QE ends Stocks Trade Sideways / Down and Bonds Rally.So now when QE is going into reverse, QT, Bonds are supposed to Sell Off and Stocks will do OK?Rates are where they are DESPITE the Fed, not BECAUSE of the Fed.  

Blue Steel 309 Thu, 10/26/2017 - 14:06 Permalink

Why is there a Fed managing the "economy"? Or meddling in it, to be more accurate. It seems all this talk is unnecessary complication to obfuscate the illegitimacy of the system and the field of economics is predicated on mass delusions that the underpinnings of global economics are not scams for the powerful to steal labor from the weak.

ByTheCross Blue Steel 309 Thu, 10/26/2017 - 17:07 Permalink

"Why?" is a good question that you're supposed to ask.If you analyse 'global economics' as 'steal labour from the weak' to benefit 'the powerful', you end up with thermodynamic nonsense.Theft only works within a system. A system of theft is as nonsensical as pulling yourself up by your bootstraps, or putting a dynamo on the front wheel to power a motor on the back wheel of a bicycle.Therefore, what we have is a one-shot harnessing, of a cart-horse destined to die.But the big question, is to what use has the horse's work been put?

In reply to by Blue Steel 309

Conax Thu, 10/26/2017 - 14:15 Permalink

Riight. All they have to do is say they are going to tighten up, and that real soon. Then January comes and they say that they will tighten up in April.. When the routine delays are criticized, they'll just say they are tightening up, then issue phony reports that say they did it. All the while CTRL-Ping their asses off.When fiat currency creation is your power and the only tool in the drawer, what else is there to prop up this failing system?They will CTRL-P until they can't CTRL-P no more.  The big *POP* will be heard 'round the world.

Dwain Dibley Conax Thu, 10/26/2017 - 16:34 Permalink

The Fed does not create fiat currency.In point of fact, it is illegal for the Fed to use fiat currency for any purpose other than supplying bank demand, which is determined by depositor demand.Banks buy fiat currency from the Fed with their reserve assets held at the Fed.  And the Fed uses those assets as collateral to get fiat currency from the Treasury.Currently, there is a total of $1.53-Trillion in U.S. Fiat Currency in circulation around the globe.  Of that, $280-Billion is in circulation within the U.S.  Of that, $72-Billion is held in bank vaults.That $72-Billion in U.S. Fiat Currency held in bank vaults backs the $1.9-Trillion in credited demand deposit accounts.  It also backs the $9.3-Trillion in credited savings accounts.  It also backs the billions in credit transactions that occur on a daily basis.  It also backs all government expenditures.And that, is the stark reality of Fractional Reserve Banking in the U.S. Fiat Currency System.  Oh and, "Fiat Currency" is "Legal Tender".Basically, what people are calling 'money' is, bank debt administered as lines of credit.This also means that all of Wall Street is one giant, debt/credit-induced, bubble.MONEY .

In reply to by Conax

Dwain Dibley Sorry_about_Dresden Fri, 10/27/2017 - 10:24 Permalink

$2.4-Trillion of the $4.5-Trillion of the assets held at the Fed belong to the banks, not the Fed.Another $1.53-Trillion of assets are held as collateral backing the issue of legal tender from the Treasury to the Fed.Currency in circulation is all the money there is, the rest is either bank debt administered as lines of credit or asset values, not money.

In reply to by Sorry_about_Dresden

Sorry_about_Dresden Dwain Dibley Fri, 10/27/2017 - 15:01 Permalink

There is only $41,227,000,000 paid in capital, i.e. "reserves" of member banks including surplus, held at the Feral Reserve. See bottom of page 6. The other $2,400,000,000,000 - $41,227,000,000 is assets held by member banks the Feral Reserve claim is being promised, not held, as collateral. The member banks are leverage at levels of 16:1, according to BIS guidelines written in Basel. I believe it is either Basel 2 or Basel 3 rules. Member banks can use those instruments, most likely UST bonds, to collateralize many obligations and we will never know until other institutions call that collateral, the proverbial tide going out. Only then will we find out every institution is naked, w: the exception of GS, of course. Just read how the Feral Reserve is totally ingrained completely MAKING the UST bond market!!!!

Through September 2011, the end of the sample period in our study, the Federal Reserve (Fed) purchased $1.19 trillion of Treasury debt. These purchases are equivalent to about 28% of the total outstanding stock of these securities at the beginning of the QE program of Treasury securities in March 2009, and about 15% of the total outstanding stock of these securities in September 2011. is my understanding of the balance sheet.How is it not rational to believe the Feral Reserve is commiting fraud by interfering in, supposed, free UST bond auctions, and inflating asset prices not only in MBS market, but also in the stock market using their trading desk to buy instruments such as S&P e-mini futures?Those are whitepapers published by the Feral Reserve boasting about interference in markets, it is like a man bragging about his virility after he impregnates his mother and sisters. It is sick, it is a plauge in need of elimination. The balance sheet does not tell story of what is really occurring.The Feral Reserve claims, as assets:U.S. Treasury securities      $2,465,727,000,000 (Includes securities lent to dealers under the overnight securities lending facility)Mortgage-backed securities $1,770,563,000,000 So instruments they claim as assets are lent out so banks can apply massive amounts of leverage to participate in Feral Reserve Dutch auctions they use to create false demand. Probably much greater leverage than is allowed by Basel accords.What will occur when RE prices experience massive deflation once again?The only thing halting the massive deflation in 2007-2008 was intervention by Feral Reserve overtly purchasing MBS, creating false demand, bidding against owners of real assets! Is this the policy they will continue to follow? Will they become the nation's landlord when they foreclose on every property owner in the country? They will just sell these MBS to member banks, financing the loans at discount window rates, and they will just expand the balance sheet ad infinitum.When you consider real property owners, who are not member banks, you have to realize they are precluded from participating in making a real market, because the Feral Reserve is giving member banks low interest rates, which leaves private owners of real assets unable to make any profit on their assets. So the Feral Reserve is precluding the citizens of this country from creating real wealth, only the joohs in the hellish circle are allowed to use the fiat to make profits. No goyem is, ever, allowed access to the fountain of fiat.I am no expert, by any means, but I can read the whitepapers published by the cabal, and the speeches they have given to member banks, to figure out their nefarious intentions.For example, Ben Bernanke said in 2002 during the planning of the 2008 meltdown:

Of course, in lieu of tax cuts or increases in transfers the government could increase spending on current goods and services or even acquire existing real or financial assets. If the Treasury issued debt to purchase private assets and the Fed then purchased an equal amount of Treasury debt with newly created money, the whole operation would be the economic equivalent of direct open-market operations in private assets.

here:… was proposing the idea:

We can print as much fiat as we want to purchase assets, it will not be inflationary as long as we contain the fiat within the virtuous circle of member banks.

He basically said, quite clearly, the Feral Reserve would not intervene to enhance the general welfare of the population, this is clearly not a goal. The fiat would only be available to member banks to maintain the appearance of solvency of member banks.We are better off lobbying our representatives to pass legislation that would nullify any UST bonds residing on the Feral Reserves balance sheet, and only honor UST bonds owned by citizens and foreign gov'ts, force the Feral Reserve into bankruptcy, force them to sell the MBS portfolios TO THE PUBLIC in open auctions to facilitate REAL price discovery, so regular citizens could once again create wealth for their own ends, re-establishing the system under which Andrew Jackson did operate, and fought so hard to establish when he did not renew the charter of the 2nd US central bank. Interest rates need to rise so people who inherit property, or real entrepreneurs, can again create wealth without undue interference in the market by a central bank.  As painful as it will be, this nation needs real price discovery. Back in the day owners of property could owner finance to buyers and make real profit. The Feral Reserve has crowded the investors out of this market by suppressing real interest rates. Precluding the Feral Reserve from these markets is the only answer. What have we to lose? We can only gain!

In reply to by Dwain Dibley

Dwain Dibley Sorry_about_Dresden Sat, 10/28/2017 - 17:31 Permalink

If you take $1,000.00 cash to the bank and deposit it and the bank credits your deposit account with the amount, did the bank just buy your cash dollars from you?  No, it didn't.  Well, that's what the Fed does when banks deposit assets at the Fed, crediting their accounts with the amounts, providing 'liquidity' (also referred to as "reserves" and also "money supply" depending upon the Fed/FOMC's "monetary policy" needs) which are then used within the electronic interbank settlements system.The best way to nullify the USTs on the Fed balance sheet is for people to withdraw their legal tender money from the banks, all of it.The Fed uses the USTs (bank reserves) as collateral backing the issue of legal tender from the Treasury, effectively monetizing those USTs, which pays down the debt. The Keys: Legal tender and Payment of obligations and interest on the public debtThe Fed's use of MBSs (a non-monetary instrument) in that process of legal tender acquisition from the Treasury could be illegal and should alarm everyone because they are unnecessarily perpetuating U.S.G. debt.  If the Fed wants to use MBSs in its credit operations, who gives a shit, but using them to acquire legal tender, that's whole different matter.

In reply to by Sorry_about_Dresden

Sorry_about_Dresden Dwain Dibley Tue, 10/31/2017 - 21:34 Permalink

If the Fed wants to use MBSs in its credit operations, who gives a shit, but using them to acquire legal tender, that's whole different matter.

You should care! When the Feral Reserve becomes THE market maker of MBS this drives up RE prices.When the Feral Reserve became The market maker in UST this artificially, and in direct contradiction to free market forces, this suppresses interest rate, which is totally unfair to people that own real assets because it precludes them from earning what would be a real interest rate on those assets. The Feral Reserve is stealing from the from the working class to give to the Feral Reserve primary dealers, this should upset YOU.

In reply to by Dwain Dibley

itstippy Thu, 10/26/2017 - 14:44 Permalink

It is possible for both stocks and bonds to go down simultaneously.  Suddenly there's no "rotation" of funds out of one asset class and into the other; instead there's just plain old asset destruction across the board.  It happens when all asset classes are severely overbought with leveraged funds.  Some black swan catalyst appears, the music stops playing, the margin calls start coming in, and all Hell breaks out in the financial world.Over-financialization and over-leverage is a lot of fun, until somebody gets their eye put out.    

rejected Thu, 10/26/2017 - 14:52 Permalink

Who the hell are they going to sell to? Only ones stupid enough to buy would be government and how would that work as they would have to print more.It's all BS.... If they lowered the amount by 500 billion how would you know someone bought or they just cooked the books? Yea, go ahead,,, tell me all about government oversight.

Sorry_about_Dresden taggaroonie Fri, 10/27/2017 - 19:23 Permalink

This FRB whitepaper gives clues to actions necessary to maintain the appearance of a liquid UST market:

To wit, page 4:

Through September 2011, the end of the sample period in our study, the Federal Reserve (Fed) purchased $1.19 trillion of Treasury debt. These purchases are equivalent to about 28% of the total outstanding stock of these securities at the beginning of the QE program of Treasury securities in March 2009, and about 15% of the total outstanding stock of these securities in September 2011. 

They boast about this heresy like mentally ill man bragging of his prowess after impregnating his mother and sisters.It is sick!   

In reply to by taggaroonie

Sorry_about_Dresden rejected Thu, 10/26/2017 - 23:14 Permalink

Feral Reserve is only buyer of UST debt. Look for yourself, the Feral Reserve published white paper bragging of their prowess buying trillions of dollars of UST bonds. Here:

Why should we believe they are not currently fabricating UST bond market???

I firmly believe these crooks are in the UST bond market buying up bonds no other country will buy with money being printed by the US Treasury.

The Feral Reserve admits as much in this paper to wit:

"Through September 2011, the end of the sample period in our study, the Federal Reserve (Fed) purchased $1.19 trillion of Treasury debt. These purchases are equivalent to about 28% of the total outstanding stock of these securities at the beginning of the QE program of Treasury securities in March 2009, and about 15% of the total outstanding stock of these securities in September 2011."

I also suspect the the coupling of oil prices and stock market index fluctuations are due to Feral Reserve PPT. When oil prices go down there is less demand for UST requiring the PPT Feral Reserve trading desk to purchase these bonds, instead of deploying this false liquidity to buying S&P e-mini futures, and Dow futures, contracts on the CME

If PRC ever starts to sell UST on secondary market the joohs will be ruined, and we in turn will be freed from their oppression and dominion.

Read, reflect, offer your opinion. Hit me up at

In reply to by rejected

TK69 Thu, 10/26/2017 - 16:30 Permalink

uh.,. if banking excess reserves are over 2.8 quadtrillion and the fed assets are approx 4.5 Trillion, how are they going to unwind?

TK69 Thu, 10/26/2017 - 16:24 Permalink

uh.,. if banking excess reserces are over 2.8 quadtrillion and the fed assets are approx 4.5 Trillion, how are they going to unwind?