It is becoming increasingly clear that the Fed’s taper, the slowdown in the central bank’s balance sheet growth (chart below), is unlikely to damage credit expansion in the US.Fed’s balance sheet (YoY)In fact – and many economists find this counte…
Barry Ritholtz wrote an opinion piece on Bloomberg today arguing that it’s hard to criticize the Fed’s QE programs simply because we don’t know what would have happened without them. Since this is not a “controlled” experiment in which we can compare a…
Since the Fed announced the reduction in securities purchases (“small taper”), the treasury curve has undergone some strange adjustments. Here is what the impact has been since the close on December 17th. Why would the 5-year note sell off the most whi…
The Federal Reserve remains concerned about exiting the massive bond buying program that has been in place for over a year now. The program has become a bit of a trap (see post), creating a dependence on an unsustainable levels of stimulus. The concern…
The end of the global “commodities supercycle” (see post) has been devastating for a number of nations with significant natural resource export sectors. Over the past decade, the rise in commodity demand and prices has often masked structural issues in many of these nations and delayed much-needed reforms and industry diversification. When the good times ended, a number of countries were caught unprepared. Some argue that the impact is not limited to emerging markets and includes to some extent nations such as Canada (see post) and Australia (see post).
While we’ve discussed some of the economic implications of the Fed’s current policy, let’s now take a quick look at the impact of QE on the overall mortgage bond market.
Here is a simple fact: the amount of mortgage-related securities in the US has been declining since 2008 – after reaching just over $9 trillion at the peak.
The reason is simple. With a large portion of all mortgages funded via the bond markets, the ongoing decline in total mortgages outstanding results in smaller MBS balances. Of course as the population grows and more homes are built (albeit very slowly) this trend should reverse.
And now with these market dynamics as the backdrop, put the Fed into the mix. At it’s current pace the Fed is taking about half a trillion of MBS securities out of the market. In fact the Fed is now removing more than 100% of the paper that is being issued. The supply of agency (Fannie and Freddie) MBS securities in the market is declining sharply as the Fed reduces the total “tradable float”. According to Credit Suisse, without the Fed’s anticipated taper in Q1, the demand for agency paper could outstrip the supply by $340bn in 2014, creating a liquidity problem.
CS: – Liquidity in the MBS market could come under pressure in the coming months due to Fed’s settled purchases exceeding 100% of gross issuance of non-specified conventional 30-year pools. Tradable float in conventional 30-year MBS should decline between 6% and 30% during the year, increasing the risk of a potential liquidity disruption in the market under longer taper delay scenarios.
Here is what the conventional 30-year agency MBS float will look like under the taper vs. no-taper scenarios (chart below). Without the taper, the float in these bonds will decline by 30% from the October levels. These are dangerously low levels for what used to be one of the largest bond markets in the world.
|Source: Credit Suisse|
Taper therefore becomes essential in order for liquidity to stabilize and for more private market participants to begin returning to this market.
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As we approach the fifth anniversary of the start of the first quantitative easing program, some are asking the thorny question about the so-called “distributional effects” of these unprecedented programs. Who really benefited since the first QE was launched? There is a great deal of debate on the topic, but here are a couple of facts. Financial asset valuations, particularly in the corporate sector have seen sharp increases. For example the S&P500 index total return (including dividends) has delivered 144% over the 5-year period. Those who had the resources to stay with stock investments were rewarded handsomely.
But what about those who didn’t have such an opportunity? For example savers, particularly retirees who had to stay in cash? They were hurt severely by record low interest rates (negative real rates – see post). And those who had neither the savings nor significant stock investments, relied on house price appreciation or growth in wages. The housing recovery has certainly been helpful (for those who kept their homes), but according to the S&P Case-Shiller Home Price Index, US housing is up less than 5% over the past five years. Not much of a “wealth effect” for those without stock portfolios. And when it comes to wage growth, the situation isn’t much better. The chart below shows hourly earnings growth of private sector employees.
It therefore shouldn’t be a surprise that the three rounds of quantitative easing over the past five years rewarded those who had the wherewithal to hold substantial equity investments. Everyone else on the other hand – which is the majority – was not as fortunate.
Perhaps the best illustration of these distributional effects is in the chart below. It shows the relative performance of luxury goods shares with wealthier clients vs. retail outfits that target the middle class. The benefits of QE are clearly not felt equally by the two groups.
So as we prepare for the Janet Yellen’s ultra-dovish Fed (see story), it’s worth thinking about the past five years and the cost of growing distributional effects in the United States. For now there is plenty more cheap money to help those with large stock portfolios.
JPMorgan: – There are debates about whether a 0% cost of money helps anything except financial asset prices … All we know is that the Fed has a story to tell (“cheap money is good”) and they are sticking to it.
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Weak inflation readings in the US continue provide the Fed with the rationale to maintain securities purchases in what amounts to a “QE trap”. With the PCE inflation measure once again below one percent, the FOMC doves fear that “taper” could bring about deflationary pressures. The risk of course is that inflation measures remain benign and what was meant to be a short-term policy measure extends beyond anyone’s expectations.
Scotiabank: – The Fed’s preferred measure of inflation — the price deflator for total personal consumer expenditures — came in at +0.9% y/y in September. We feel that markets are underestimating the importance of this observation to the Fed. That is tied with April for the softest inflation reading since October 2009 when the US economy was just beginning to emerge from recession.
The forward looking inflation measure derived from TIPS yield (breakeven), has now also turned lower after what looked like a recent upward movement.
Similarly, we’ve seen a slump in commodity prices (see discussion), which is another signal of weak inflation readings.
With inflation measures remaining this low, many argue (see story) that there is no rush to begin exiting the current monetary policy. The fact that the US monetary base is now 4.5 times greater than it was 5 years ago and capital markets are now fully addicted to ongoing stimulus does not seem add any urgency for these economists. The longer this goes on, the more difficult will be the exit, making it harder for the Fed to pull the trigger. Welcome to the QE trap.
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Here is an observation. The last couple of years show some interesting similarities to the period ending in early 2005. The reason for such a comparison is that then, just as now the Fed began to gradually exit its highly accommodative policy.The perio…
The FOMC’s decision yesterday to continue buying securities at the same pace moved a number of markets. But who exactly benefited from these moves (h/t George H)? Here are a few select markets.Stock investors got a nice boost and precious metals …