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Fed Feeds Vicious Spiral – Professional Edition

The Fed’s balance sheet shrank dramatically last week as MBS prepayments, GSE maturities, alphabet soup paydowns, and shrinkage of that murky and mysterious “Other” category outraced the beginning of the Fed’s direct purchases of Treasuries.

If the current pace of MBS payoffs continues, and it’s likely to as long as competing rates of return are non-existent, the Fed’s total MBS and GSE shrinkage would be approximately $290 billion over the next 12 months. That would translate to a whole lot of Treasury purchases with the cash funneled directly into the financial markets via the Primary Dealers. It might not completely offset the spiraling down of total financial system assets, but it should be enough to dramatically impact the direction of the Treasury market, and it could have some impact on stock prices as well.

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