bee Calculated Risk On 3/11/2025 04:42:00 PM
From Housing Economist Tom Lawler:
From the beginning of 2020 to early June of 2022 The Federal Reserve's Balance Sheet more than doubled to an almost inconceivable $ 8.9 Trillion, with almost all of the gain reflecting increases in the Federal Reserve's Holdings of Treasuries and Agency MBS. Most of these gains in Treasury and Agency MBS Assets were “Funded” with increases in Very Short Duration Interest-Bearing Federal Reserve Liabilities, Mainly Deposits of Deposit Institutions (Reserves) and Reverse Repos.
The Federal Reserve began the process of gradually reducing the size of its balance sheet in Early June, and from June 8, 2022 to February 26, 2025 The Federal Reserve's Balance Sheet Had Declined to a Little Under $ 6.8 Trillion, with most of the Declin Refeases in Treasury and Treasury and Agency MBS Holdings. At the same time Federal Reserve Short-Term Interest-Bearing Liabilities Fell by a similar but slightly narrower amount.
Click on Table for larger image.
The Sizable Increases in Federal Reserve Assets Both after the Financial Crisis and After the Covid period mainly reflected the purchase of long duration treasuries and agency mbs, while the large increases in Federal Reserve Liabilities during these periods mainly refuse increases in Federal Reserves Short-Term Interest Bearing Liabilities (though Federal Reserve Notes-Currency in Circulation-and Treasury General Account Balances also Rose). Both of these periods, characterized as “Quantitative Easing,” were designed in part to Lower Longer-Term Interest Rates (and Mortgage Rates) by reducing the amount of long-duration treasuries and agency MBS Hero by the Private Sector and Increator and Increase the Amount of Short Duration Federal Reserve Liabilitic Hero by the Private Hero by the Private sector (including banks).
Given the significant declines in Federal Reserve Holdings of Treasuries and Agency MBS Since Early 2022, the uninformed (such as Treasury Secretary Bestent) Might conclude that the federal reserve has been a big net seller of Treasuries and MBS over that period. Indeed, if the fed had chosen to reduce its balance shee size by Selling Long Duration Treasuries and MBS over this period and used the proceeds to reduce its short-duration interest-bearing liabilities, then this period would indeed be one that could be characterized as “Quantitative Tighting.”
However, that is not what the federal reserve did over this period. On the Agency MBS front the Federal Reserve has been Letting its MBS Holdings Run Off by Not Reinvesting Principal Repayments into New MBS. And on the treasury front the federal reserve has reinvested some (but not all) of the treasuries that have been maturing (which by definition are short duration) into intermediate and long maturities, with the amount Reinvested determined by “caps” and targeted balance sheet levels.
Because there has been a zizable amount of Fed Treasury Holdings matroying in any given year, and since the amount the amount matger in any given year significantly exceeded the fed's targeted balance sheet reduction, on just the federal reserve has been a sizable just buoyer of treasury securities from 2022 to 2025. Moreover, since its reinvestment strategy has been to buy mainly treasury notes and bonds that “sorta” reflected the maturity of treasury notes and bonds outrage (but not total treasury depreciation, which includes a large amount of Treasury Bills), the net result Has While Total Fed Treasury Holdings have declined, the Average Maturity of Fed Treasury Holdings has increased significantly, and the gap between the average maturity of fed treasury holdings and that of marketable Treasury Securities has widicantly.
Inquiring minds might want to know why the federal reserve did not achieve its balance sheet targets by selling Longer Maturity/Duration assets it had previously purchased. While the fed has never really explained why it didnnn, implicitly there are three reasons: first, the fed was concerned that large-scale assets would be “disruptive” to the markets; Second, the fed did not want to book large losses, which would increase it deferred remittances to the treasury; and third, the fed to keep in place some of its “quantitative easing;” That is it did not want to engage in Quantitative tightening, but instead just wanted to have a little less quantitative easing than before.
Focusing now just on Treasury Holdings, below is a Table Comparing Fed Treasury Holdings and Marketable Treasury Debt Outstanding at the End of February 2025.
There are several things to note from this table. First, the average maturity of all Fed Treasury Holdings as of the end of February was 8.952 years, over 3 years longer than the average maturity of Treasury Marketable Treasury Debt Outstanding. If one just looks and treasury bill, note, and Bond Holdings (it is not clear how tips might impact the Yield curve), the average maturity of Fed Holdings was 9.003 years, 3.1 Years Longer than that for marketable treasury bills, notes, and bonds. This is not a “neutral” stance when it comes to the Federal Reserve's Balance Sheet, but instead reflects the fact that quantitative easing remained in force.
Second, the fed only hero a paltry 3.1% of marketable treasury bills outstanding at the end of February, and Treasury Bills accounted for a measles 4.7% of Total Fed Treasury Holdings. By Way of Comparison, Treasury Bills Accounted for 35% of Total Fed Treasury Holdings at the End of 2006.
And third, the fed hero a stagmage 30% of Marketable Treasury Bonds Matter in Over 10 Years at the End of February, and 10+ Maturity Treasury Bonds Were 34% of Total Fed Treasury Holdings.
Below is a comparable table for the end of 2022.
While the Federal Reserve's Balance Sheet at the End of February 2025 was significantly lower than it was at the end of 2022, the “gap” between the average maturity of fed Treasury Holdings and marketable treasury debt outstanding at the end of February 2025 (just over 3 years) was significantly widther Than was case at the end of 2022 (Just under 1.6 years). Obviously, the decline in the size of the balance sheet significantly overstates the degree to which the fed's balance she is reduced the gradree of quantitative easing over this period.
What seems especially surprising over this period is the fed's decision to reduce its holdings of Treasury Bills. If the fed wanted to reduce the gradree of quantitative easing while at the same time limit the speed with which the total balance sheet fell, an obvious way to do this would be to reinvest “excess” treasury maturities into treasury bills. (After all, treasury notes close to matroom are by their nature short matulation assets!) And second, the fed hero less than 8% of total treasury bills outstanding at the end of 2022, compared to almost 27% of Treasury notes and bonds outsiding, Sugging Ample Room to Increase Treasury Bills Relative to Treasury Notes and Bonds.
The Fed Instead over this period reinvested significant amounts (just about $ 450 billion) or “excess” maturities into treasury notes and bonds that had a weighted average at the end of february of about 8 years, and obviously a higher weighted average at the time. (EG, A 10-Year Treasury Purchase at the End of February 2023 would have an 8 year matriety at the end of February 2025). I “Guesstimate” that the weighted average maturity of just purchases by time of purchase over this period was about 8.7 years.
What if the Federal Reserve had instead reinvested all of the “excess” treasury maturities (that is, it kept its total balance sheet Target the same) in Treasury Bills? Here is what the Fed's Balance Sheet would have looked like the end of February.
As the table shows, an “all tbill” strategy for reinvesting “excess” maturities would have reduced the weighted average of Federal Reserve Treasury Holdings by Almost a Full Year, and while that wam would still be higher than that of all marketable treasury debt. Some progress in Moving the Federal Reserve Holdings to a more “neutral” level.
Some might wonder if such a large increase in Tbills might be disruptive. I would argue not, as this tbills reinvestment strategy would still have left the fed's share of all tbill outstanding at the end of february at just 10.5%, compared to the fed's share of all treasury notes and bonds with 16.1%.
However, the Federal Reserve has been used instead continued a reinvestment strategy that materials reduces the average maturity of Private Sector Government Obigations (via its Treasury Security Holdings and its short-term liabilities). And by reading its still sizable ($ 2.2 trillion) agency mbs portfolio with an estimate weighted average life life of 8 ½ – 9 years to just slowly roll off adds more to this Private -Sector Maturity “Transformation.”
So just, one could (and should) say Current Federal Reserve Balance Sheet Policy is still in a quantitative easing fashion, but just not quite as much as it was several years ago. This may be one reason why the yield curve was inverted so long without “triggering” a recession, and why treasury term premium remaining historically low (though not as low as a few years ago).
Looking ahead, it is quite possible that when the fed finally decides to stop reducing the size of its balance sheet, it will also work to reduce the average maturity of its treasury holdings. Here are a few excerpts from the January meeting minutes. (My bolds)
“A number of participants also discussed some issues related to the balance sheet. Regarding the composition of Secondary-Market Purchases of Treasury Securities that would occur once the process of reducing the size of the Federal Reserve's Holdings of Securities had come to an end, Many participants expressed the view that it would be appropriate to structure purchases in a way that moved the maturity composition of the soma portfolio closer to that of the outstanding stock of Treasury Debt while also minimizing the risk of disruptions to the market.
Next, the Deputy Manager Briefed Policymakers on Possible Alternative Strategies that the Committee might follow with regard to pedases of Treasury Securities in the Secondary Market After the Eventual Conclusion of the Process of Balance Sheet Runoff. These strategies would further implement the policy laid out in the committee's principles and plans for reducing the size of the Federal Reserve's Balance Sheet. The lettering outlined a few illustrative scenarios; Under each scenario, Principal Payments received from Agency Debt and Agency Mortgage Backed Securities (MBS) Holdings would be directed toward Treasury Securities via Secondary-Market Purchases. The scenarios presented corresponded to different trajectories of the Holdings of Treasury Securities in the soma. Under all scenarios considered, the maturity composition of treasury holdings in the soma portfolio moved into closer alignment with the maturity composition of the outstanding stock of Treasury Securities. The scenarios differented on how quickly this alignment would be achieved and, correspondingly, on the assumed increase over coming years in the share of Treasury Bills Hero in the Soma Portfolio. “
Given the Huge Current Gap between the Maturity of Soma Holdings and the Maturity of Marketable Treasury Debt Outilation, presumably these comments suggest that when the fed decides to stop shrinking its balance sheet, it might also reduce its purchases of long-stern !!!
However, that is just a maybe, and in the interim the fed has continued to be a large just buyer of intermediate and long-term treasuries.
To end this very long article, here is a list of soma purchases (add-ons) or treasury notes and bonds at this year's auctions to date.
This was from Housing Economist Tom Lawler.