Thursday 21 March 2019
Fed: towards "QE Infinity"?
Beyond the confirmation that it did not intend to raise its key rates in 2019, the Fed has announced measures related to its balance sheet policy that are a game-changer for the Treasury securities market.
FOMC members lowered slightly their growth forecasts
FOMC members lowered their GDP growth forecast from 2.4% to 2% for 2019 and on the top of that, the statement mentions a slowdown in activity at the beginning of this year, particularly household consumption and business investment (the Atlanta Fed’s nowcast points to a GDP growth of only 0.4% in Q1). However, they maintain a growth projection of 1.9% for 2020 and 2021, which corresponds to their estimate of long-term growth. We can infer from this that there is no questioning about the durability of this economic cycle and there are no fear about a possible upcoming recession.
The "dots" significantly revised downward
While December's "dots" indicated 2 rate hikes in 2019 and one in 2020, the new projections show zero hike in 2019 and one hike in 2020 (they were close to pointing zero hike in 2020). The status quo for the fed funds is now clear for 2019. During the press conference, Jerome Powell even gave some credibility to the idea that the rate tightening cycle was over in the base case scenario ("the data is currently not sending a signal that we need to move in one direction or another in my view ") and we can probably consider the rate hike indicated in 2020 by the" dots" as an option in the case of unexpected acceleration of inflation. In any case, the ‘dot plot’ does not explore at all the idea of rate cuts over the next three years.
The timing of the end of the reduced balance sheet has been specified
• The balance sheet reduction operation will be slowed down between May and September: the amounts of non-reinvestments of Treasury securities will decrease from a maximum of $ 30 bn per month to a maximum of $ 15 bn per month, while the amounts of non-reinvestments of MBS will remain at a maximum of $ 20 bn per month.
• From October onwards, the balance sheet reduction will be completed: all the maturing Treasury securities will be reinvested and the maturing MBSs will be reinvested in Treasury securities (up to a maximum of $ 20 bn per month). The size of the balance sheet will remain constant but the composition will change over time, with less MBS and more Treasury securities.
On the following two charts, we represent the monthly change in the stock of Treasury securities and MBS held by the Fed, with the rules that prevailed so far and with those that will prevail from now on (for MBS, we do the assumption that redemptions will be equivalent in the future to the average of the monthly change in the stock over the last 6 months, ie $ 15 bn).
The supply-demand balance of Treasury securities is strongly and durably modified
Specifically, while its stock of Treasury securities was supposed to fall rapidly with the old rules, the Fed will now become net buyer of Treasury securities from October this year and until further notice. This substantially changes the game for the supply-demand balance on the Treasury securities market over the coming quarters.
With the rules that prevailed until now, the stock of Treasury securities held by the Fed should have reached about $ 1800 bn by the end of 2020 while under the new rules, it could reach $ 2300 bn at the same date. So, the change in the balance sheet policy implies a change in the Fed’s expected demand for Treasury securities of around $ 500 bn over the next two years.
Make no mistake, this is not a Quantitative Easing announcement per se because the decisions taken during this FOMC will not involve an increase in excess reserves ... but the Fed will still purchase around 15 bn $ of Treasury securities per month in net terms from October, which has never been seen outside QE periods. These amounts will even be revised up later, when the Fed's balance sheet will start to grow "in a natural way" (ie when the excess reserves will be too low to allow an “efficient and effective implementation of monetary policy”). This gives off a feeling of QE infinity…
Date of publication : Thursday, 21 March 2019
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Senior Strategist at CPR AM
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