One aspect of quantitative easing that many may have missed is just how much money the Fed is set to make off these programs.
Last March the Fed starting their $1.25 TRILLION program of purchasing Agency MBS. For an entity that can borrow on the cheap (i.e. free) the returns have been spectacular.
The latest program is basically doing what banks have been doing for ages... borrowing short, lending long.
How much can be made?
The Fed's statement provides details of their purchases (here NY Fed). Using the current yield levels to determine an estimate yield of their Treasury purchases, an estimated yield of 1.2% - 1.6% seems likely.
Quick and dirty math = the Fed is getting PAID
Source: NY Fed
Thursday, November 4, 2010
Fed is Literally and Figuratively "Printing Money"
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Maybe I'm missing something, but:
ReplyDeleteFed buys treasury bond with funds from THE TREASURY at 0%.
That longer term treasury bond pays, let's say, 3%. It's the TREASURY paying itself that 3%.
Unless for some reason you choose to isolate the Fed's balance sheet from the rest of the Treasury, when the Fed buys a Treasury bond, they're basically vaporizing it. It doesn't exist anymore because the holder of the bond is also the payer of the bond.
MBS's a different potato. Though presumably, the Fed plans to hold to maturity.
I agree with your comments when looked at in net (the Fed gives their "profit" back to the Treasury, so definitely a circular reference).
ReplyDeleteWhile purchases will roughly match new Treasury issuance with the $600 billion that was announced, with the additional paydowns from mortgages the Fed is taking out an additional $300 billion out of the market.
The result is that the profits from the MBS purchases will allow the Fed to "buy back" some of the outstanding debt on the Treasuries behalf.
The iShares MBS etf (symbol MBB) has tracked the chart posted quite nicely:
ReplyDeletehttp://www.etfreplay.com/etfimages/mbb.png
But what about the interest rate risk that the Fed is assuming. The profits could vaporize if rates rise, couldn't they?
ReplyDeleteThe conventional argument against that is that they can hold the securities to maturity and thus mark-to-market isn't an issue but it seems it would be if they were forced to sell in order to reduce the money supply if inflation becomes an issue.
It seems that there is more risk here than they want to advertise. They're getting really long and that has lots of tail risk.
Your thoughts.
"But what about the interest rate risk that the Fed is assuming. The profits could vaporize if rates rise, couldn't they?
ReplyDeleteThe conventional argument against that is that they can hold the securities to maturity and thus mark-to-market isn't an issue but it seems it would be if they were forced to sell in order to reduce the money supply if inflation becomes an issue."
My thought... this is the best possible outcome. The whole purpose of QEII is to prevent deflation and to cause inflation. Thus, if they lose money in real terms due to inflation, they got a result that they are hoping for.
Not to mention the benefit of inflation on the balance of all the other debt outstanding that inflates away.