Cutting to the chase of the minutes, there is nothing in it of relevance that hasn’t been spoken about from all the Fed members we’ve heard from since this meeting three weeks ago. On the rate side, if it wasn’t for the invasion they would have hiked 50 bps. Going forward though, expect them not to back off, but which has been well telegraphed in speeches. “Many participants noted that one or more 50 bp increases in the target range could be appropriate at future meetings, particularly if inflation pressures remained elevated or intensified.”
With respect to the balance sheet, “Participants generally agreed that monthly caps of about $60b for Treasury securities and about $35b for agency MBS would likely be appropriate. Participants also generally agreed that the caps could be phased in over a period of three months or modestly longer if market conditions warranted.”
This QT commentary compares with how it went down last time where the ultimate cap was $50b and started at $10b when $6b of Treasuries and $4b of agency MBS rolled off in October 2017 and scaled up by $10b at three month intervals over a 12 month period until it got to $50b. So it took one year to go from $10b per month in QT to $50b and the Fed is now planning on getting to $95b in just 3 months. This is now referred to as ‘rapid’ by Vice Chair Brainard.
This plan by the Fed on QT I want to emphasize is easier said than done. At least for the next 12 months, it will be pretty easy for the Fed to shrink the Treasury side of their ‘portfolio’ because $1.08 Trillion of their $5.76 Trillion of Treasury holdings have a maturity of one year or less. Of that $316b has a maturity of less than 3 months. Easy peasy. The tough part is with respect to their MBS ‘portfolio’ which holds $2.72 Trillion of securities. Days of prepayment in this cycle is essentially over which has dramatically lengthened the duration of this portfolio, thus limiting any short term natural run off. That means the Fed will have to start selling agency MBS outright in order to achieve their roll off goals. Now that is something they are well aware of and some officials have talked about it but in reality it raises the risks of losses when they do as the prices realized will most likely be below the price they paid when initially bought.
Buying Treasuries as part of QE and getting out via QT is straight forward. MBS is not. And for the latter right now, I’m pretty confident the Fed did not envision the market environment we are currently in when they discussed buying MBS again in March 2020 which was an event that had NOTHING to do with the housing market as they just bought them again out of habit it seems. It’s the classic case of a diver in a swimming pool who only asks how deep after they already jumped in.
This said, hopefully they’ll have plenty of buyers wanting agency MBS as it still is basically government backed paper with a bit of extra yield but the process probably won’t be without disruption.