The Federal Reserve has three primary tools to conduct Monetary Policy: reserve requirements, the discount rate, and open market operations (Quantitative Easing). Open market operations are how the Fed uses its balance sheet to provide liquidity to the market. More details can be found here. The Fed defines Open Market Operations as:
Open market operations involve the buying and selling of government securities. The term “open market” means that the Fed doesn’t decide on its own which securities dealers it will do business with on a particular day. Rather, the choice emerges from an “open market” in which the various securities dealers that the Fed does business with – the primary dealers – compete on the basis of price. Open market operations are flexible, and thus, the most frequently used tool of monetary policy.
This is a fancy way of saying the Fed prints money to buy up US debt, providing liquidity while also keeping interest rates low. Essentially, Quantitative Easing (QE) is debt monetization. This analysis explores the changes in the Fed balance sheet to better understand what the Fed is buying and when.
The latest balance sheet figures show the total at 8.22T, up 143B from the prior month end, but down in the past week by 19B. The chart below shows how the Fed Balance sheet has grown by instrument over the last 18 months. The major surge from COVID can be clearly seen as 2.5T was added within 2 months. The monthly changes since then reflect QE on autopilot. Autopilot targets about 120B in monthly purchases split by 40B in MBS and 80B in US Treasuries. As the numbers show, this is not exact, but an approximation.
The “other” category surged and fell last year due to Repurchase Agreements. This is the opposite of the Reverse Repos. In standard Repo Agreements, the Fed buys from a dealer with an agreement to return the security. This was designed to be temporary in nature rather than a permanent addition to the balance sheet. These repurchase agreements put a floor under the Treasury market by providing unlimited liquidity.
Figure: 1 Monthly Change by Instrument
The table below shows the breakdown of holdings by instrument and the period over period change as indicated. The main takeaways:
- The balance sheet has grown by 1.27B over the last year, averaging about 100B a month rather than the target of 120B
- More recent months are trending above this average and target
- The balance sheet grew by $4T over 3 years, the majority of which occurred since the start of Covid
- In the latest month, the focus has been on MBS(65B) and shorter0-term treasuries of 1-5 years (39B)
- The Fed is not putting much emphasis on short term debt adding only 63B over 1 year
- The market for short term treasuries is still very liquid and does not need Fed support
- Almost 40% of the Treasury Balance sits in 1-5 year maturing debt with another 40% in 5+
- MBS has grown by 451B over the last year and Treasuries have grown almost 1T
Figure: 2 Balance Sheet Breakdown
The chart below shows the percent distribution by product. While absolute values have increased quite significantly as shown in the table above, the distribution of holdings has changed some. MBS made up 40% of the balance sheet 3 years ago, but the number has fallen to under 30% as short term (<1 year) and medium-term (5-10 years) has increased from 9% to 12.6% and 7% to 11.7% respectively.
Figure: 3 Total Debt Outstanding
Zooming into weekly
Another chart to look at is the weekly change in the balance sheet. Anyone who follows the balance sheet closely will notice it dips once a month before jumping back up. The chart below shows how the fed balance sheet changes week over week. As seen, there are a few consistent trends:
- A series of MBS mature about every four weeks
- This results in a slight decrease in the balance sheet for that week
- A bulk of MBS is also bought every 4 weeks that is larger than the maturing MBS
- This creates a surge in the balance sheet for that week
- Treasury securities mature and are purchased with less volatility
The latest week saw 37B in MBS mature with 20B in Treasuries purchased. It is likely that in 2 weeks there will be a large purchase of MBS.
Figure: 4 Fed Balance Sheet Weekly Changes
The table below shows how the latest week compares to the weekly averages over 4, 24, 52, and 156 (3 years) weeks. The weekly averages are shown to gauge whether the current periods (1 and 4 weeks) are accelerating or decelerating. The averages are all divisible by 4 because that is about how many weeks a full cycle takes as shown in the plot above.
The Fed has averaged about 35B per week for 4 weeks totaling 140B, which is slightly above the 120B monthly target. The latest week saw a more than 50% increase in debt maturing in 1-5 years compared to the 4, 24, and 52-week averages. Perhaps this helped drive the 2-year rate from 25bps back to 20bps over the last two weeks.
Figure: 5 Average Weekly Change in the Balance Sheet
As mentioned, the Fed is monetizing US Debt. The chart below uses the data from the debt analysis and matches it up with the Fed balance sheet holdings. While this is not a perfect one-to-one match due to the nature of reporting, the outcome can be seen below. This chart focuses specifically on Treasury securities: Bills (<1 Year maturity), Notes (1-10 years), and Bonds (10+ years). This is the bulk of debt issuance and Fed purchases.
As can be seen below the Fed has monetized a large percentage of debt issued since Jan 2020. The focus is clearly seen in Notes and Bonds to keep a lid on long-term rates. The first chart shows the debt added in each of the last 4 years by instrument. The bottom chart shows the percent of that debt the Fed has purchased. In 2020, the Fed monetized more than 100% of notes and 90% of bonds. In 2021 those numbers have fallen to 35% and 46% respectively. While not a complete monetization, this is still massive in terms of scope.
Figure: 6 Debt Issuance by Year and Instrument
Figure: 7 Fed Purchase % of Debt Issuance
The final plot below takes a larger view of the balance sheet. It is clear to see how the usage of the balance sheet has changed since the Global Financial Crisis. The tapering from 2017-2019 can be seen in the slight dip before the massive surge due to COVID.
There is no way the Fed will come close to shrinking the balance sheet at this stage. With more fiscal spending on the horizon and an economy addicted to low interest rates, it is probable that the growth of the balance sheet may accelerate rather than decelerate.
Figure: 8 Historical Fed Balance Sheet
What it means for Gold and Silver
The Fed balance sheet is one of the drivers to the expanding money supply. The Fed’s monetary tools are used to keep rates low and cheap credit flowing. If the Fed keeps up the monetary stimulus, it will continue to drive inflation higher. If the Fed were to ever try and taper, allowing longer-term rates to rise, it will put pressure on many areas of the economy, including the federal deficit. In either case, Gold and Silver should benefit from high inflation if the Fed keeps printing or a shrinking economy if the Fed tapers.
Data Updated: Weekly, Thursday at 4:30 PM Eastern
Last Updated: Jul 28, 2021
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