MORNING BID – Dot Matrix

Apr 10, 2014 12:52 UTC

The Federal Reserve did it again, giving back to the markets at a time when it wasn’t expected, and showing once again that the early months of a new Fed chair’s tenure are fraught ones, in terms of interpreting monetary policy.

Janet Yellen probably didn’t mean to suggest rate hikes could come as soon as six months after the bond-buying program ends for good. And the release of the Fed minutes also demonstrated that the Fed – even in discussing projections – worried about how it would all look, specifically the “dot matrix” that showed several Fed members saw higher rates before long, and really, that it was all just kind of overstated. (Yellen even said this at her press conference – that the dots did not mean what you thought they meant).

Either way, that’s wreaked some havoc on expectations for policy, with the market shifting back towards thinking this is all going to come down a bit later than expected. This comes just after the most recent Reuters primary dealers’ poll that suggested major strategists were finally getting comfortable with the idea of possible rate hikes in the first half of 2015 rather than later – there were 8 who saw that happening out of 18, compared with just 4 in the previous poll. CME Fedwatch data shows now the chances of a rate increase before July at 42 percent, down from 52 percent on Tuesday.

“The latest round of minutes highlighted a Fed that in the interest of being ever-more transparent really continues to muddy the waters even more,” wrote Tom Porcelli, fixed income strategist at RBC. But honestly? Early in a Fed chair’s run, that’s just not unusual, and difficult for the market to take after spending several years getting used to someone’s tendencies.

So that happened. Really, on some level we’re still talking about developments scheduled to take place more than a year from now, and markets can only discount so much.
Either way, it helped unwind some of the selling that the market had seen in the short end of the curve, steepening the curve once again and reducing some concern about the front end and the effects of the higher short-term rates and the flattening of the yield curve. It also sparked some life in the biotech and other momentum names as well, though for how long is another question.

Markets will keep an eye on the 30-year bond sale later today, the last of three auctions in the quarterly refunding. Lately, Treasury auctions have been a complete wild card, with bidding by direct bidders – those who aren’t going through the 22 primary dealers in Treasury securities who directly deal with the Treasury and New York Federal Reserve – all over the map.
Direct bidding was high in some recent auctions, especially in the three-year auction on Tuesday, and then fell off again on Wednesday. Coupled with the recent spike in bank buys of five- and seven-year paper, there are a lot of questions around the dynamics in the Treasury market right now.

We’ll be looking at this phenomena later in the day and the market gets the third of its three auctions this week, the 30-year bond sale that shapes up to be relatively attractive given the release of Fed minutes that showed the Fed’s whole deal about being more aggressive in rate cuts? Never mind all that stuff or what not, we’re going at the same pace that we’d been going.
Concern over what was to happen with the Fed minutes (just one hour after the auction) may have kept buyers cooling their heels with the 10-year note sale on Wednesday. Still, much remains unclear about activity in the Treasury market where long-dated yields remain at relatively attractive levels and the short end saw yields drop to their lowest in weeks as prices rallied after the Fed minutes.

MORNING BID – The same-store situation

Apr 9, 2014 13:36 UTC

Same-store sales figures may be enough to inspire some investors to resume paring portfolios of some consumer discretionary stocks that have underperformed in the last five or six weeks.

Equities rebounded on Tuesday, but the overall feeling is that the market hasn’t yet finished with the bout of selling infecting the high-volatility, high-beta names that dominate conversations.
Most consumer names aren’t in this rarefied air (they don’t trade at price-to-sales ratios of a gajillion) but they’ve still been a target for some time on bad news.

The ones to watch are the likes of Costco, expected to come in strongly, while teen apparel retailers face some pressure, even with easy comparisons to a year ago. Gap, Zumiez and Buckle all look to post worse year-over-year results for March, and Shoppertrak data has shown how mall visits have changed over time. People no longer wander the mall for hours, but find deals online, shop at a few stores, and get outta there. That’s not a weather thing, that’s a “how I run my life” thing.

This data is likely to be bad news. Excluding the drug store sector, same-store sales are expected to have grown at a 1.5 percent rate for March, down from the 2.7 percent growth rate for the ex-drug sector last year, according to the Thomson Reuters outlook.

Investors hope retailers see a pickup in the next few weeks and that the group’s earnings reports point to underlying demand that was at least seen in the car-sales figures and some signs of home-buying activity. That might revive some demand for that sector, which is down 5.4 percent since March 7.

Hedge funds seem to be still reducing positions in this area even as they don’t drop out of the market entirely; ETF flows this past week show more reduction in buying in consumer cyclical shares, according to Credit Suisse, though it hasn’t been terribly pronounced.

BUYING WHAT AND WHERE?
There’s been a bit of strange activity here and there in some of the official Fed and Treasury data.
First, a number of weeks ago, someone either sells or moves about $100 billion in holdings that had been custodied with the Federal Reserve – the biggest ever such move.

It has since been restored, and yet it remains a mystery; speculation had focused on Russia as the culprit, but no proof is there. Monday, new data showing who the buyers were of the most recent Treasury auctions (two weeks ago) showed a big buy by banks and other similar institutions of five- and seven-year notes. They accounted for about 15 percent of the auction, compared with about 0.11 percent of the February auctions of five- and seven-year paper.

Again, there’s not much in the real facts here and a lot of speculation – quarter-end positioning wouldn’t seem to make sense, as banks looking to shore up their balance sheets could just buy lots and lots of bills. Is it mortgages? Unclear.

MORNING BID – $4 trillion, through the eye of a needle

Mar 28, 2014 13:19 UTC

The shift in the stock market away from momentum names and toward value is encouraging at least in some sense because it points to an ongoing appetite for equities rather than a reduction in interest there. However, one has to add the caveat that the Federal Reserve is still very much a part of this market, even as it diminishes its footprint.

The $55 billion in bond buying per month definitely continues to underpin rates and keep funding costs low for companies. Still, the market has reduced its reliance on the central bank and yet bond yields continue to sink, at least in the long-dated part of the curve, where the 30-year note neared 3.50 percent and the 10-year came close to 2.60 percent yet again.

The immediate expectation would seem to be for still-higher rates, particularly in the short end of the yield curve, where investors would be thought to trim positioning as the yield curve flattens. The market-implied rates suggest bonds are still a ways behind where the survey expectations are for the Federal Reserve – a two-year rate of just 0.45 percent will do that.

On the other hand, Citigroup analysts point out that the Fed has been consistently overestimating inflation and growth, and the Fed continues to want to adjust its target for when it will start raising rates, moving most recently from “definitely when unemployment hits 6.5 percent!” to “definitely when we say so, based on lots of indicators or something!” So maybe it’s not an underestimation so much has it is prudence. And those expecting more curve flattening, that is, buying in the short end and selling in the long end, would be ignoring that forward rates – the market’s expectations for rates going out into the future – already imply substantial flattening out (47 basis points between the 10 and 30, compared with 56 basis points in June 2004 when the Fed last began rate increases).

What’s that make out as? Essentially, Citigroup things it’s not a given that the short end will continue to sell off in a rapid fashion, but that things might take time, and the market is already on some levels pricing in a rate increase. So the slow unwind of the most accomodative monetary policy ever has begun, and it’s starting to show in rates markets, if not equities. Reducing or rolling off this $4 trillion balance sheet is threading the smallest needle in history will be quite the feat, if it can be done without more major shocks.

MORNING BID – Hi Janet, Here’s a Selloff.

Mar 20, 2014 14:06 UTC

Welcome Madame Chair, here’s a market selloff for you.

Fed Chair Janet Yellen made some news that she didn’t expect yesterday. She perhaps thought she was offering some clarity when she answered the question from Reuters’ Ann Saphir as to when the Fed might start raising interest rates. That’s not how it worked, although at least in this case she didn’t mouth off to Maria Bartiromo the way Ben Bernanke did eight years ago.

What we didn’t see in her answer on the distance between the end of QE3 and the first rate hikes of “six months” (or something like that), is whether we will start to see any kind of reaction from the primary dealers surveyed by Reuters yesterday.

Most still see the Fed not raising rates until late in 2015 although there were a couple of notable changes. Barclays moved up its expectations for the rate increases to the second quarter of 2015. There were still, however, four dealers that do not see rate hikes coming until 2016. This may, on some level, put the Fed behind the curve as interest-rates adjust, though it was notable to see several Fed members in the Fed’s projections believe rates should be at 1 percent by the end of 2015. (It wasn’t much of an adjustment, but somehow, the way it looked on the dot matrix chart the cool kids were talking about was enough to get the bond market in a lather. The stock market, of course, didn’t react until someone (Yellen) told it what to do.)

What is undetermined now, however, is what the Federal Reserve will be looking at when it decides whether to raise rates or not. The market has gotten awfully used to the idea of a threshold on the unemployment rate that made things easy. Without that, it reverts to looking at a number of indicators, although the Fed chair yesterday did say that she thought the unemployment rate was one of the best indicators.

It is perhaps to the markets’ credit that many commentators remarked on the Fed’s use of several indicators as worrisome. In years past, there was great praise for Alan Greenspan just because he used to discuss looking at various pieces of data in his bathtub or whatnot. Now the market finds such alchemy to be less comforting. That may at least be a sign of maturity. Or, perhaps, the Fed has through years of communication efforts changed the markets’ belief that the Fed chair should be this omniscient presence in the market. If so, that bodes well for what is usually an awkward transition between Fed chairs. This may make that much easier, regardless of what Yellen said.

MORNING BID – Janet Yellen’s rain (snow) check

Feb 27, 2014 14:16 UTC

This is the thing about delaying the new Fed chair’s follow-up testimony by two weeks due to bad weather, you actually make the second hearing something that’s potentially interesting. (It will depend, of course, on whether members of the Senate Committee ask provocative questions, and while you can lead a horse to water, well, you know.)

In the interim two weeks since Janet Yellen last appeared before Congress, the U.S. economic picture has gotten much more muddled. That’s mostly because of poor retail sales and employment figures, and the out-of-control situation in Ukraine which has led to a regional flight of some assets. There’s also been some interesting comments from the likes of Fed Governor Daniel Tarullo, who suggested the Fed should be paying more attention to the formation of asset bubbles and the use of monetary policy to curb them. That anyone is surprised at this shows how pervasive the “Fed put” option has become in the discussion of Fed activities, so we’ve really lowered expectations here.

Meanwhile, Boston Fed head Eric Rosengren said the Fed is looking very closely at activities in emerging markets, which is sort of obvious in a sense but contradicts, if only modestly, Yellen’s thoughts two weeks ago. And really, the Fed’s ability to influence economic activities overseas in some of the world’s developing markets or troubled spots is even weaker than what it can exert over U.S. demand. So maybe it’s just one to grow on.
Either way, Yellen would probably want to comment on the situation, if, again, a smart senator would think to … well, never mind.

Overnight, the situation in the Ukraine has worsened, with armed gunmen taking control of regional government headquarters in Crimea, vowing to be ruled from Russia. The Ukrainian hryvnia continues to sink while the Russian ruble plumbs new five-year lows, surpassing the previous day’s losses, and a bit of risk-off action can be seen in the zloty and a bit of better buying in Treasuries, where the 10-year yield was lately at 2.66 percent. Fund flow figures will be key to watch here to see if overseas flows increase to the U.S. or at least to the developed areas of Western Europe and Japan.

MORNING BID – But I never could find…(sha na na na, sha na na na na)

Feb 7, 2014 14:05 UTC

An odd jobs report sets the tone for what’s likely to be another choppy day in the markets – stock futures plunged, briefly, after the Labor Department said nonfarm payrolls grew by just 113,000, but the household survey saw a drop (again) in the unemployment rate to 6.6 percent on a big gain in jobs in that survey. An odd decline of 29,000 in government payrolls offset the overall about-at-trend-but-let’s-not-kid-ourselves-about-this-being-awesome 140,000 or so gains in the private jobs market, so there’s a little bit to like, some to shake one’s head at, and still more to wonder about how many people didn’t get to work because their feet froze to the ground when they tried to get into their cars.

(More seriously on that point – the establishment survey doesn’t get some kind of massive job loss just because of a storm on a particular day of surveying, so it’s not as if a snowstorm destroys job growth, so let’s not overstate the weather issue here. It’s a factor, but don’t look for a revision to +300,000 or something.)

The activity in equity futures, however, seems to point to where we’ve been all along: jobs growth, factory activity and overall economic figures are just enough to put a brake on getting any kind of incipient rally and keeping the buyers less motivated right now, though the shallow correction we’ve seen so far appears to have hit a stopping point for the time being. Futures bottomed out around 1758 on the S&P E-Minis, a few points below the level the market had been sitting at before the downdraft that took futures to about 1730 for a few days. Stocks recovered from that level and now appear content to hang out around 1760 or so or even a bit higher, while the bond market is doing something similar – a quick post-jobs rally that took yields down to about 2.64 percent on the 10-year before the buyers eased off the throttle, lifting yields again to around 2.67 to 2.70 percent. Absent more emerging markets turmoil – and this appears to have been somewhat stemmed in the last few days, though maybe that’s just because we haven’t had bad news from China in the last day or two – these levels might end up prevailing for some time.

The jobs number of course raises the usual back-and-forth about whether the Fed might decide to accelerate or decelerate its schedule for winding down stimulus, but with the Federal Reserve – and especially with a new chair coming in – predictability when it comes to this policy is probably the preferred course of action. There’s enough weather-related shenanigans and uncertainty about global growth offsetting the relatively solid economic figures for the Fed to not want to jolt markets, and the Fedsters have been talking pretty tough on this one, essentially making it clear that this wind-down will become the equivalent of stock buyback programs: They continue, no matter what, unless something drastic happens to alter that expectation.

While we’re on the subject of buybacks, Apple is upping the ante on its own share repurchase schedule, succumbing to some of the pressure from the likes of Carl Icahn and others who have demanded the company boost shareholder returns in the absence of real spending plans. And of course, Apple has a ton of cash on hand, and they’re generating enormous profits even if they’re not the growth engine they had been in the past. It’s a bit early to say that the company should be lumped in with the likes of Exxon or IBM – gigantic businesses mostly notable now for moving money around, using up their free cash flow (and then some, thanks to low borrowing costs) for buying back their own shares.

Some analysts, notably Tobias Levkovich of Citigroup, have done studies that show that serial repurchasers – those who are steadily reducing their outstanding share count (share shrinkers, to come uncomfortably close to a Costanza-ism here) – have been better performers in the stock market over the last decade, with a total return of about 550 percent coming into the year compared with the S&P, which is up about 200 percent since the beginning of 2003. From a shareholder perspective, that works as long as these companies are so entrenched that their products deliver big sales at steady margins; once they fall behind, though, look out.

MORNING BID – Turkey, the Fed, and we all float down here

Jan 29, 2014 14:46 UTC

The messy sell-off in emerging markets was stemmed overnight after Turkey surprised everyone by raising rates to 12 percent – but it didn’t last. Major averages in Britain and Germany opened at their highs of the day but have since faded, and even though the big rate increases in Turkey, South Africa and India are meant to stem capital flight, so far the market’s shooting first and asking questions later. S&P futures were up about 20 points after the Turkey rate hike – an odd move for such a localized event – and we’re seeing the reaction now, which, to quote Tom the cat about the ‘white mouse no longer being dangerous,’ “DON’T…YOU…BELIEVE…IT.” So we’re lower, and continue to head lower, and for those of you new to the markets, this is what’s called a selloff.

The big question: Will the Federal Reserve defer its tapering campaign in recognition of emerging-markets difficulty? One could say the Fed cannot be expected to act as the underwriter for global risk-taking, but you’d be laughed out of the room, given the performance of assets around the world in the last several years as the Fed went into full-QE mode.

On the other hand, there’s a difference between providing broad support to the markets (via helicopter or not) and an actual admission that you’re changing policy to respond to specific issues worldwide, and such a move strikes us as the latter, not the former. With that in mind, it would be remiss to think the Fed does not continue at its measured pace, dipping down to $65 billion in bond purchases per month this time, as Janet Yellen takes the reins and we find out what kind of situation the new Fed head has gotten herself into while Ben Bernanke eases into what one hopes is a steady and muted retirement (think Johnny Carson, not Alan Greenspan).

For one, eventually reducing the monthly stimulus to zero at least gives the Fed room to ratchet up that stimulus again if they really need to.
Furthermore, the emerging markets, in a sense, are already gone. No, it’s not a disaster yet – but the implosion of China’s shadow banking system, the resignation of every Turkish official in Ankara, and the, well, uh, never mind, Argentina is Argentina, and isn’t going to be solved by the Fed put. The Fed might give it lip service in its statement but any more than that really ratchets up the moral hazard.

Furthermore, when one takes a look at the relative strength of emerging markets stocks with the U.S. market, it’s clear EM has been struggling for a while anyway. A comparison of relative performance between the MSCI EM index (.MSCIEF, or EEM.P if you’re into the ETF thing) is at 0.7 or so, and U.S. markets have been the steady outperformer since the beginning of 2013, and that outperformance accelerated throughout the year but particularly in the second quarter when the Fed started talking about reducing stimulus in the first place.

That doesn’t mean they can or will reverse course – it makes no sense. But less liquidity washing ashore means a bad investment can no longer be covered by smoke and mirrors. The MSCIEF’s relative performance index is still looking terrible, having fallen below the 30 level that indicates an oversold condition. It’s not quite at the nadir of the June 2013 or May 2012 selloffs, but it’s close, so if there’s a place one might expect some buying, it’s now. But it’s not happening yet – and that does raise questions about whether we’ll see more soothing words from central banks.

WE ALL FLOAT DOWN HERE
Back in the USA, the Treasury is readying its first-ever auction of two-year floating-rate securities, likely to see demand from various types of investors.
There are currently more than $200 billion in agency and “supra-sovereign” floating rate notes outstanding, mostly from Federal Farm Credit and Federal Home Loan Bank, per Morgan Stanley data. So, Treasuries should add nicely to the mix here, and it’ll quickly become a very big dog in a very small pond (dogs can jump in ponds, go with the analogy). So the $15 billion will add to the week’s mix of other supply.

For one thing, this gives the Treasury the chance to manage its issuance a bit more by reducing the number of short-dated auctions of bills, instead issuing this note that resets based on market rates for floating-rate notes. It will helpfully cut back on the weird dislocations that the market has seen of late in bills that are maturing just as the United States is set to run afoul of the debt limit (again) or face some kind of annoying only-in-Washington-type spectacle.

(Of course, if it was all two-year floaters, then in the month it had more floaters coming just as a budget crisis hit, those yields would go through the roof. So you can’t entirely solve the Washington problem this way, and floating-rate notes as far as we know cannot hold Congressional office).

The other advantage for the Treasury is the lack of what’s called “term premium,” which Morgan Stanley says will lead to interest-rate payment savings.
Term premium refers to how much additional interest you have to offer someone who is taking the risk of buying longer-dated securities (and therefore risking wide swings in interest rates or other unforeseen events over a five-year period vs. say, six months). But floating rate notes have no such provision (they float, after all), so that *should* save Treasury some money.

Reuters’ bond correspondent Richard Leong points out they’re expected to sell with a yield of 0.10 percentage point, almost a quarter less in the two-year fixed-rate note supply sold on Tuesday. So, that’s savings for Uncle Sam until the FRN yield rises above the fixed-rate two-year notes. Overall, the interest rate should be greater than what’s embedded in notes, though, which is good for money market funds (they hold about $276 billion of floating rate notes already).

FRNs are great in an environment where interest rates are on the rise, which has been the case for several months now (until this month that is), and therein, of course, lies the danger. If rates fall, well, not so great, as the interest rate on the notes would be chipped away.

MORNING BID – The selloff continues in emerging markets

Jan 27, 2014 14:00 UTC

It takes a lot to overshadow the heart of earnings season and a Federal Reserve meeting but the rout in emerging markets has managed to make that happen. This week is an important one. As my Reuters London colleague Mike Dolan pointed out, it will go a long way toward determining whether this is a rapid hot-money flight that gets stemmed after a brief correction or the start of a prolonged rout.

Fund withdrawals in recent weeks have shown a steady pullback from the emerging markets, though strategists at Bank of America-Merrill Lynch believe a “contagion” point hasn’t been reached yet – that would take several more weeks of similar outflows. It remains to be seen whether that will happen or not.

Already some managers, including those interviewed by Reuters’ David Randall and Ashley Lau in a ‘How to Play It’ piece over the weekend, are starting to see buying opportunities in the countries that are less dependent on external funding and a bit less messed up in the whole “governing” thing (no, Argentina, not you, you’re pretty messed up).

The selling has continued through Monday, although for now it appears U.S. futures are inclined to move higher, though one never knows ahead of key earnings releases this week. A report overnight on capital shortfalls for European banks is also not helping sentiment in the developed world, so if anything, U.S. markets might be inclined to fade a quick rally at the open just to avoid exposure at a time when the weakest hands in the market seem to be driving the action.

Which of course leaves the Fed. There’s been rumblings that the central bank ought to pay more attention to its effects worldwide, but of course that would take the existing “Fed put” and turn into a global insurance wrap inviting people to buy stocks and punish savers in fixed income. So while there’s some concern that the Fed would elect to hold off on more cuts to its stimulus, that just doesn’t seem like a logical choice. The moral hazard is too great, even considering how much credibility the central bank lost through the Greenspan years and most of Bernanke’s.

Morning Bid — The Minutiae of the Minutes

Jan 8, 2014 13:52 UTC

December’s last salvo before going into holiday mode was the surprise Federal Reserve decision to trim its monthly $85 billion in bond buying to a more modest (but still enormous) $75 billion, that helped balloon its balance sheet to north of $4 trillion.

Suffice to say, on some levels, there was a bit of a disconnect here: The Fed’s inflation outlook showed inflation not getting back to its 2 percent target for a long time (like, forever; several years out, it was seen as just sneaking its way over 2 percent, never mind what Charles Plosser of Philly says).

With the Fed’s minutes due out later Wednesday, there are a number of unanswered questions about the Fed’s decision as Ben Bernanke exits and Janet Yellen (confirmed on a 56-26 vote, with “OMG IT’S COLD” coming in third place with 18 votes) enters the scene:

THE SCHEDULE OF REDUCING STIMULUS
There’s been no guidance on this so far. Ben Bernanke, in his final press conference as the Fed head, said he could envision a steady reduction in $10 billion increments at each meeting, which would drop the monthly buying to nothing by the end of 2014. Richard Fisher, Dallas Fed head and now a voting member for 2014, said he would be comfortable with a more accelerated rate of purchases. And dovish John Williams of San Francisco said yesterday he’d expect to see the end of buying by year-end.

So it will be interesting to see any commentary on this – whether a faster pace was considered or not. (There will probably be some boilerplate on the Fed saying it could ‘reduce at a faster pace’ or ‘resume additional purchases’ or something. Just as a warning.)

But the October minutes provide some clues, as the Fed said some participants “mentioned that it might be preferable to adopt an even simpler plan and announce a total size of remaining purchases or a timetable for winding down the program. A calendar-based step-down would run counter to the data-dependent, state-contingent nature of the current asset purchase program, but it would be easier to communicate.”

ECONOMIC EXPECTATIONS
Recent inventory figures, construction data and durable goods orders point to better-than-expected figures for the fourth quarter, and a first quarter where the economy gains momentum. The baseline projection for GDP growth in the fourth quarter has been for around 2.5 percent, but it could be higher thanks to a boost in exports.

The Fed sees 2014 GDP growth of 2.8 to 3.2 percent, which may end up being optimistic, while they see inflation as not much of a threat.
Yellen, in the past, has been more explicit about the idea of living with additional inflation, if needed, to help reduce unemployment, so there’s that. Again, that central tendency only ticks up to 2 percent in 2015 and 2016, and that’s the just the upper end of the Fed’s forecasts.

THE CONSUMER OUTLOOK
October’s minutes sounded a note of caution when it came to regular people, saying that “consumer sentiment remained unusually low, posing a downside risk to the forecast, and uncertainty surrounding prospective fiscal deliberations could weigh further on consumer confidence.“

Said fiscal shenanigans have receded for the time being (give it a day or so), which has removed a layer of uncertainty, though it’s debatable that consumers make decisions based on what’s happening in Washington to begin with. But a weak September payrolls figure and a few limp sentiment surveys put the Fed in a mind to be more concerned, and later economic figures don’t show a similar kind of worry.

Morning Bid — Just the Beginning

Dec 19, 2013 14:00 UTC

And now the hard part begins.

The Fed’s decision to reduce its monthly bond purchases to $75 billion from $85 billion suggests this is not the beginning of the end, but the end of the beginning, or some other cliche (your mileage may vary).

Later today, the Federal Reserve will release its weekly data on its balance sheet, which is expected to tip the scales at more than $4 trillion in reserve bank credit. Given that this is a slowing in growth of the balance sheet, and not a reduction, it’s not stopping there.

So this “taper” means the rate of growth finally slows, as the Fed starts to buy fewer Treasuries and mortgage securities each month.

Ben Bernanke, in his farewell presser (you could see the glee in his unmoving, implacable face), suggested the Fed might reduce purchases by a similar amount at each subsequent meeting. Assuming that goes to plan, this implies a slow reduction of purchases until November, when logically, instead of cutting from $15 billion to $5 billion, it may just do away with it altogether.

Adding what’s left to buy in December, that brings the balance sheet ultimately to about $4.5 trillion. This then needs to eventually be unwound through allowing bills, notes, bonds and mortgage securities to mature or be sold – the ultimate in threading a Monster truck through the eye of a needle.

Taking a closer look at that balance sheet, letting it all mature out (sort of the way the Mets are paying disgruntled ex-outfielder Bobby Bonilla for another million years, and you’re forgiven for not getting that reference) would eventually allow the Fed to exit the markets around the time the earth crashes into the sun. Or, more accurately, in the realm of 2024 to 2028 or so, depending on the situation (assuming no other catastrophic recessions that require a stop or reversal of the tapering process).

It isn’t likely, but for kicks, here’s how the balance sheet looks:
The Fed holds about $2.18 trillion in Treasuries and $1.48 trillion in mortgage-backed securities. Breaking it down by maturity, it’s got about $748 billion in notes maturing between one and five years from now, all of it in Treasuries; $864 billion in five-to-10-year notes, most of which are still Treasuries, and $572 billion in longer-dated governments and the bulk of that $1.48 billion in mortgage notes as well.

Of course, it’s not all going to be sold. At the beginning of 2007, the Fed held about $900 billion in marketable securities, of which only about $150 billion were of a maturity greater than five years. Any effort it makes is going to be slow – Bernanke said that himself in a speech in February 2010.
Draining reserves through reverse repos and other agreements will be a primary way of going about business, and that will help tighten the Fed’s control over the funds rate again.

With regard to the Treasuries and mortgage debt, the Fed is likely to discontinue rolling over that debt for starters – it doesn’t want to simply sell it all and panic the bond market. This version would slowly reduce the amount of outstanding debt, sure, but the rate early on would be so slow as to be non-existent.

With just $750 billion in debt (as currently constructed) maturing in the next five years, by the end of 2018, the Fed balance sheet – assuming an additional $500 billion in purchases and no other offsetting operations (though there will be) – would still be somewhere around $3.8 trillion.
Bernanke, in that same speech, said the Fed “anticipates that its balance sheet will shrink toward more historically normal levels and that most or all of its security holdings will be Treasury securities.”

When would that be? Well, again, the mortgage debt is almost exclusively super-long-dated stuff, so the Fed most certainly at some point will start selling securities – when the “economic recovery is sufficiently advanced.”

Daniel Thornton, economic adviser at the St. Louis Fed, leans toward the idea of selling bonds rather than just paying additional interest on excess reserves – which has a number of other complications.

The problem with the sales, he says, is the Fed could lose money, though most of the bonds were at least bought when bond prices were much lower and yields were higher (the buying that’s been done in the 2012-mid 2013 area is probably the most problematic, particularly the longer-dated issues).

“The likelihood of significant capital losses could also be reduced by selling longer-term securities and simultaneously purchasing short-term securities in advance of reducing the overall size of the Fed’s balance sheet,” he wrote in August. So there’s that.

The Fed’s exit strategy appears to be on a timeline similar to removing U.S. troops from the Korean Peninsula, in other words. Will the markets freak out? Not if they’re bored to death, which seems to be the objective. But hey – whatever works.

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