US Debt Monetisation - the Fed's role
Weekly update on US Treasury debt supply against purchases made by the Federal Reserve. The balance between the two is key in determining Real Yields and private sector asset price volatility
31 May 20 : As the Treasury continues to issue large amounts of debt, the Fed is purchasing an ever decreasing amount of USTs.
Year to date summary :
Last week saw a large $266bn of new debt issued. Of this, only $61bn was issuance of short end Bills with the remaining $205bn of longer dated coupon paper as the US Treasury starts to "term out" the debt.
Against this maturity extension program, the Fed is reducing its purchases, with last week's $21bn of UST acquisitions the lowest since February.
In the last 9 weeks, because of the much reduced Fed purchases, the US Treasury has had to raise $1.25trn from US private savings and/or from foreign savings, but as the following chart shows, the UST still hold $1.5trn of cash in its account at the Fed (i.e. money that has yet to be spent).
As suggested last week, such large debt and duration increases will start weighing on real yields and swap spreads, bear steepening the curve as long end real yields rise. Below is an update of the real yield chart that was posted last week. This clearly depicts that New Issuance plus secondary market selling is larger than secondary market purchases, especially on longer end maturities.
31 May 20 : The US government rakes in $1trn of cash in the last 8 weeks.
In the week to 28th May, the
Fed purchased a "mere" $ 27bn of US Treasury securities (USTs), the smallest weekly amount since 12th March.
Outstanding marketable debt increased by a large $ 237bn.
The net result is that last week the US Government needed the US Private sector and/or Foreigners to fund $ 210bn of the deficit - the largest weekly cash requirement 2020 year to date.
The draining of resources from US Private Savings/Foreigners is beginning to accumulate. In the 8 weeks since the 2nd April, when the Fed stopped buying more USTs than the weekly net supply, the net cash requirement has totalled just over $1 trillion. That 8 week cash requirement to fund the deficit is the same as the total for the whole of 2019 ($953bn).
Despite the large cash requirement and poor auction results, the supply/demand balance remains very stable. After the March wobble, when foreigners were very large sellers of USTs, necessitating large scale FED purchases, real yields (left) and swap spreads (right) have remained very stable during the $1trn draw on private and foreign savings. If anything, there is a justifiable steepening of the the real yield and swap spread curves, which is likely to continue as long as the Fed eases back on its purchases. (due to the duration supply - see previous posts).
21 May 20 : The NET supply to the market, post fed purchases is ramping up.
In the midst of the stock market sell off in March, the Fed was buying more US Government Bonds than the US Treasury was issuing. This was crucial to bring stabilisation to financial markets as the Fed actions meant that the market knew that it would not have to divert savings from the private sector to finance the substantial US deficit. The fiscal response to the Covid19 pandemic has been huge, requiring a net issuance of $ 2.32trn to 21 May. The Fed has purchased $ 1.75trn year to date.
The table below shows the weekly net supply and corresponding Fed purchases of USTs. The right column shows the Net Cash that the private sector has had to divert to fund the deficit. Note how the Net Cash was negative in March, as the Fed bought more bonds than were issued, and how the Net Cash subsequently turned very positive. Indeed, the private sector has had to divert almost $800bn to fund the deficit in the last 7 weeks. That number is very large indeed - if it was to continue at this rate over the next 2 months, it would reach and exceed the total net requirement for the whole of 2018 ($1.4trn).
Below are the monthly summaries of Net issuance and Fed purchases in 2020, which again shows the tapering of Fed purchases in April and May:
The whole Net Issuance vs Fed Purchases remains key to financial markets due to the impact that the balance of UST supply/demand has on US Real Yields. For the moment Real Yields are relatively stable, suggesting that there is good private sector demand for this enhanced supply. Anchored Real Yields allow risk assets to remain steady and perform. Should there be any move upwards in real yields, which must surely be likely if this pace of net supply continues to come to the market, then there could be a return to risk asset price volatility.
30 April 20 : The Fed is now allowing NET US Treasury Supply to hit the market.
The US Treasury and Federal Reserve have published their balance sheets as at 30 April, so the market can now digest the total amount of debt issued for the month of April and for the first four months of the year, and how much of that debt the Federal Reserve has purchased. All the numbers are large, and fortuitously for private sector asset values, they balance pretty much, limiting how much the private sector and/or foreign savings are required to fund the US Government deficit.
Total net supply of US Treasuries and Bills for April was $ 1,373bn ($ 2,496bn of new bonds that were issued against $ 1,123 of bonds that matured). The Fed purchased $ 1,132bn bonds in the month. The net result was that foreigners/domestic US private savings had to absorb $ 241bn of net new supply. The fed has eased its foot off the pedal - a couple of weeks ago it was purchasing MORE bonds that the net supply (see 20 Apr post below).
A couple of new points to highlight:
As can be seen from the table and chart below, the Fed now owns 21% of the outstanding debt, the highest percentage in 20 years.
The Fed US Treasury holdings are only 59% of its total balance sheet, a low proportion in respect to past years. The FED's huge balance sheet expansion has also been for other facilities, including MBS purchases and repo.
MARKET CONSIDERATIONS : Real yields have been relatively stable since the FED started buying, especially as there is a maturity mismatch between supply and demand. Most of the government fund raising has been at the short end of the curve (just like during the GFC), whilst only $ 335bn of the Fed's $ 3,945bn US Treasury securities are short term bills.
On the 6th May the US Treasury will announce its future auction calendar. The market should expect more issuance on longer dated maturities. When that starts happening, then the FED might have to ramp up its buying to prevent any rise in real yields (which would destabilise private sector assets.
23 April 20 : The Fed has eased up its' purchases
Since the US Government announced in March that there would be a huge fiscal support to combat the fallout from Covid19 the Federal Reserve had been buying more bonds than the US Treasury had been issuing. The net result of the FED's policy was to reduce the free float of USTs in the market, despite the gargantuan debt issuance.
However last week the Fed purchased less USTs than were issued, resulting in "only" $1.051trn of purchases month to date against the larger $1,101trn of debt issuance (table below). Thus so fare for the month of April the debt free float has increased by $ 50b. This extra debt coming to the market has had to be absorbed by foreign and/or private domestic savings.
$50bn is not a large number - to put it into context, the average net monthly supply between 2010 and 2019 was $77bn. Unsurprisingly, Real Yields were virtually unchanged last week, despite the positive net supply.
Table below shows the Outstanding US Treasury Debt and the size of the FED's balance sheet, including the holdings of US Treasuries. 21% of the US Debt is now owned by the Federal reserve, still not too different from the levels seen pre GFC.
20 April 20 :Update of the data showing the US Debt Supply and Fed's Balance Sheet
In December 2007, just before the Great Financial Crisis, the Fed's total assets were $894bn. The largest component was its' $ 754bn holding of US Bills and Treasuries (UST), and that stock represented 17% of outstanding US Federal Debt.
As of 16th April 2020, the Fed's total assets now total $ 6.28trillion. It's UST holdings of $3.7trn are a similar 20% proportion of US outstanding debt. However they represent only 59% of the Fed balance sheet, as there are now $1.5trn of Mortgage Backed Securities and $ 1trn of other assets, which includes $ 330bn of loans and repos, and $ 393bn of central bank liquidity swaps.
This month to 16th April, the Fed has bought $ 904bn of USTs, which is MORE debt than the $846bn that US Treasury has issued. The free float of USTs in financial markets has therefore reduced by $58bn in the month of April.
A final chart shows the difference in the FED's actions and mindset compared to the GFC. During that period the FED expanded its' balance sheet pretty quickly by $ 1tn, but NOT its' UST holdings - they actually declined. It was only in 2011 that the FED seriously started buying USTs in its' QE program. This time around it has both increased its' balance sheet AND its' UST holdings.
The aggressiveness of the FED actions actions, both in terms of timing and size, should ensure that risk free real yields do not rise, which is absolutely key for reducing broader risk asset volatility.
Powell's announcements suggest that this aggressiveness can be unlimited. Monitoring the weekly UST supply vs Fed demand data will confirm if this true or not. Undoubtedly this is the case at the moment, and for the time being there is little to think that the Fed will ease up on this aggressiveness.
11 April 20 : 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.
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 Data https://fiscal.treasury.gov/reports-statements/dts/ Federal Reserve Balance Sheet Weekly https://www.federalreserve.gov/releases/h41/