FED “Over Monetising” the US Federal Debt

The Federal Reserve (Fed) is keeping to its’ word that it will increase its’ Balance Sheet in an unlimited fashion to support the US Government’s fiscal program and to ensure financial markets remain stable. From the 1st Jan to the 9th April, it has increased its balance sheet by $1,924bn to $6,055bn. This note summarises the recent data with an important conclusion for risk assets.

Chart below left shows the 20 year growth in US Federal Marketable Debt, and the growth in the Fed’s holdings of that debt in the form of US Treasuries and Bills – the right hand chart is just the last 4 years. The impact of the Great Financial Crisis (GFC) on substantially increasing the US Federal debt is clear, as is the recent Covid19 pandemic. More subtle is that the pace of debt increase started already rising in 2018 with Trump’s fiscal largess.

The Fed’s response to the debt increase can also be seen – it has been far more aggressive during this Covid19 phase compared to the GFC period.

The charts below show this Fed aggressiveness by depicting the monthly changes of the Outstanding US Debt (i.e. the net monthly debt supply) and of the Fed’s Balance sheet (i.e. its’ monthly net purchases or sales of US debt). The red line is the standout. It shows the months when the amounts of the Fed’s purchases were GREATER than the net debt supply, i.e. when the Fed reduced the market free float of US Bonds and Bills. As can be seen, this did not occur around the GFC, only during QE periods well after the event, and in a smaller size compared to now.

From 1 Jan to 9 Apr this year, the US Treasury increased its’ debt by $ 1,030bn and the Fed bought $ 1,189bn, thus buying an EXCESS $ 159bn of that net supply. The real excess purchases started occurring in March, which coincided with the high in Government Bond Real Yields and the low in equity and corporate bond prices (see post on Real Yields).

CONCLUSION

This “over debt monetisation” shows just how quickly and how aggressively the Fed reacted to the market turmoil. This was done to prevent further market volatility arising from potential concerns over the government’s ability to finance its’ debt.

This Fed policy action is of course everything but “temporary” in nature – the rise of US debt post GFC and the Fed’s inability to contract its’ balance sheet in the last 10 years is testimony to this untold truth.

This over debt monetisation should not be considered a one off event in nature - it happened in 2011 and 2013.

By adding this “over debt monetisation” to the Fed’s extraordinary decision to buy High Yield debt ETFs, it is becoming clear the lengths to which the US Central Bank will go to maintain market stability and keep assets prices elevated. This was the conclusion of my first post – “it’s time to consider the unthinkable on a large scale” - the implications for financial markets are substantial.

Edward Ballsdon 11 April 2020

Sources: The data and charts are derived from three sources:

US Outstanding Debt Monthly Data https://www.sifma.org/resources/research/us-marketable-treasury-issuance-outstanding-and-interest-rates/ Daily Datahttps://fiscal.treasury.gov/reports-statements/dts/ Federal Reserve Balance Sheet https://www.federalreserve.gov/releases/h41/