Yesterday the Fed released its latest balance sheet data: at $3,478,672,000,000, the Fed’s assets reached a new all time high of course, up $8 billion from the prior week and up $615 billion from last year – after all with 4 years almost in a row of debt monetization or maturity transformation, either the total holdings or the 10 Year equivalency of Bernanke’s hedge fund rise to new record highs week after week.
But that’s not the bad news: the bad news, at least for Bernanke, and why the Fed has no choice but to taper is monetizations (however briefly as following the next market crash Bernanke or his replacement Larry “Mr. Burns” Summers will be right back in) is that since the Treasury is about to print less paper (recall: lower budget deficit, if only briefly), and the Fed is monetizing the same relative amount of paper, the Treasurys in the private circulation book get less and less, as more high quality collateral is withdrawn by the Fed.
This is precisely what the Treasury Borrowing Advisory Committee warned against in May. This is also precisely why the Fed’s “data-dependent” taper announcement is pure and total hogwash: the Fed knows it can’t delay the delay (pardon the pun) of Treasury monetization as doing so only risks even further bond market volatility as less Treasury collateral remains in marketable circulation, and as liquidity evaporates with every incremental dollar purchased by the Fed instead of by the private sector.
So just how bad is the situation? Quite bad. As as of last night, courtesy of SMRA, we know that the amount of ten-year equivalents held by the Fed increased to $1.608 trillion from $1.606 trillion in the prior week, which reduces the amount available to the private sector to $3.603 trillion from $3.636 trillion in the prior week. There were $5.211 trillion ten-year equivalents outstanding, down from $5.242 trillion in the prior week.
After the Treasury issuance, maturing securities, rising interest rates, and Fed operations during the week, the Fed owned about 30.86% of the total outstanding ten year equivalents. This is above the 30.63% from the prior week, and the percentage of ten-year equivalents available to the private sector decreased to 69.14% from 69.37% in the prior week.
In other words, in 1 week the Fed’s “take over” of the bond market continued at a brisk pace of 23 bps, which is its average weekly uptake. This is roughly equivalent to 10% of total private collateral moving from private to Fed hands every year!
So basically every year that the Fed does not taper its purchases, Treasury issuance being equal (and it is declining), the Fed removes 10% of high quality collateral from the world’s biggest bond market.
And that, in a nutshell, is what Tapering is all about: the realization, and then the fear, of what happens if and when the Fed continues its monetizations of public debt to the point where there is so little left, that when a trade takes place the entire curve moves by 1%, 2%, 5%, 10% or more….
Everything else is smoke and mirrors.