billaster wrote: ↑Sun May 22, 2022 11:41 am
nedsaid wrote: ↑Sun May 22, 2022 10:58 am
billaster wrote: ↑Tue May 17, 2022 6:06 pm
Kevin K wrote: ↑Tue May 17, 2022 9:46 am
Beware the Fed's balance sheet unwinding
"Historical data shows that stock markets have reacted poorly when the Fed has contracted its balance sheet and reduced liquidity – and the effect is more pronounced when Fed actions deviate from what the market expects."
Beware the correlation implies causation fallacy.
There has been extensive research about the effects of Quantitative Easing on monetary policy. The effect is pretty mild. QE only reduces long term rates by about 20 basis points or 0.2%.
This small effect isn't surprising. At its maximum the Fed was buying about $4 billion of treasuries daily in the open market which trades more than $600 billion per day. So the Fed's purchases are just a fraction of one percent of treasuries traded each day, barely enough to move prices.
So why does the Fed do QE if the effects are so small? It's because it's only the last resort after all it's other tools have reached their limit with short rates at zero.
The effect of balance sheet expansion is small and you would expect balance sheet contraction to have a similar small effect.
What is really happening is that the Fed is now using its primary guns, raising short term interest rates, to slow the economy and the stock market is reacting to the expected slowdown. It just so happens that the Fed is contracting its balance sheet at the same time, but that isn't what is causing the slowdown. Correlation is not causation.
You could interpret the balance sheet unwinding as perhaps having a signalling effect. Since QE is the last thing the Fed tries after lowering short term rates, reversing QE is the first thing it does when raising short term rates.
The Fed has purchased $5 Trillion in Treasuries in 13 or so years and that has to have had an effect. Quantitative easing was not insignificant.
Extensive research on quantitative easing says that long term Treasury yields were reduced by about 0.2%. The effects of quantitative easing were more significant for riskier corporate debt and mortgage backed securities, about 1.0%
As large as you might think Fed purchases were, they are pretty small in the context of the enormous bond market. The Fed was buying about $4 billion in Treasuries a day when the market was trading over $600 billion in Treasuries per day. That's a fraction of a percent of daily trading.
I would assume in accordance with research that quantitative easing lowered Treasury yields by 0.2%. When they stopped buying this month, it increased rates by about 0.2%. When they start selling next month, I would expect it to symmetrically raise Treasury rates by another 0.2%. Keep in mind that these rate increases are superimposed on the short term rate increases of the Federal Funds Rate, 0.50% this month.
Quantitative easing is relatively ineffective compared to the Federal Funds rate, but it's all you've got when short rates are already at zero.
The Fed owns 20% or so of the National Debt, that is not insignificant. All of that bond buying did have an effect. Yes, $600 billion in Treasuries trade every day, but certainly $600 billion of Treasuries are not created each day. The National Debt is $30.4 Trillion, if $600 Billion are traded each day, the entire debt will turn over in less than three months. If you take, $3 Trillion and divide it by 365, you come up with about $8.2 billion of new Treasuries created daily. If you allow for business days, let's say 250, that is a creation rate of exactly $12 billion a day. So the Fed, by your numbers, was buying 1/3 or more of the new Treasury Debt being created each day. That my friend, is a lot. We also have to account for the fact that the Government is rolling over debt every day, replacing a matured Treasury instrument with a new one. (My numbers assumed a $3T deficit which won't last, but help make my argument. When the deficits are smaller than $3T the percentages of new Federal debt bought by the Fed increase even more).
Vineviz shares your opinion that Quantitative easing had less effect on interest rates than what was generally believed. Keep in mind though that the economy is very complex, lots of things that determine such things as interest rates and inflation rates. Hard to say exactly what the effect of Quantitative easing really was but it was a lot. It helped re-inflate the depressed Stock and Real Estate markets. It certainly helped the Bond Market. Hard to quantify exactly what the effects were but they were significant.
Pretty much, when new debt was issued to deal with Covid-19, the Fed bought ALL of it. That had to have had an impact.
A fool and his money are good for business.