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It’s a well-known secret that the Federal Reserve has been losing billions of dollars under its quantitative tightening (QT) – its greatest losses ever. The last time the Fed lost money was 1915. However, the Fed says it doesn’t matter because it’s all baked in to its “Deferred Assets,” the Fed’s IOU to itself (but actually to taxpayers). An inverted yield curve caused payments on the Fed’s liabilities to exceed receipts on its assets. Expenses exceeded revenues.
To stop the hemorrhaging, the Fed has engineered a return to a normal yield curve that is not inverted by continuing to let the market set long bond rates. Instead of stepping in to buy long-term Treasuries as it has under quantitative easing (QE), the Fed is allowing its bond holdings to mature without replacement, thus winding the Fed balance sheet down from $9 trillion to $7 trillion.
Short-term rates are going down because the Treasury is issuing related debt at lower rates. Meanwhile, long-term rates are going up because the Fed is not intervening.
A vicious cycle
The Fed is trapped in a vicious cycle, as shown in the following graphic. Can you see a way out?
It’s like the roundabout in National Lampoon’s European Vacation, a traffic circle that dooms Chevy Chase and family to endless circling. In this recent loop, the Fed has succeeded in reducing its balance sheet. Before QE, the Fed typically held $1 trillion, but that escalated to $9 trillion under QE. These balances evidence the degree of the intervention required to control interest rates under a zero interest rate policy (ZIRP).
Conclusion
It's interesting to note that, in this current loop, a stock market correction was avoided. Rising interest rates did not reduce stock prices. It’s conceivable that investors are bidding up stock prices as an inflation hedge, or it may be that artificial intelligence is the new dotcom. In the dotcom era, prices could grow to the sky.
Instead of reacting to a market correction as it did in the 2013 Taper Tantrum, the Fed moved to reduce rates because inflation appears to be under control. It has stimulated an economy that is growing. The economy doesn’t need stimulation, so overheating could happen. We will see.
Here we go again.
Ron Surz is president of Target Date Solutions, developer of the patented Safe Landing Glide Path and Soteria personalized target date accounts. He is also co-host of the Baby Boomer Investing Show. Surz’s passion is helping his fellow baby boomers at this critical time in their lives when they are relying on their lifetime savings to support a retirement with dignity, so he wrote a book, “Baby Boomer Investing in the Perilous 2020s,” and he provides a financial educational curriculum.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
