Currently, the Fed holds around $1.4 trillion of MBS on its balance sheet. It seems as if the only way the Fed will be able to unwind those positions is by holding them to expiration because of political pressure of keeping mortgage rates low. As a result if inflation picks up, the Fed will not be able to control it. Any thoughts on that?
I’ve tried to think my way through this. I think one of the reasosn for Operation Twist had something to do with this. It was clear once the details were ironed out that this would drop the 30-year fixed rate significantly. So by using Operation Twist they may be trying to push for another strong round of refi’s in order to speed up the unwind. Makes sense to me, although I dont know how sustainable this program will be. I know the banks will be starting to cry loudly before too long, so we shall see.
It holds less than 1.4 Trillion in MBS, according to latest B/S it holds 870B. It can sell a number of other securities if inflation really starts to pick up. It can sell ST Treasuries, and even gold. Remember though, if inflation picks up, that means housing prices have also risen.
I don’t think there are enough UST debt holdings to fully fight inflation. If they try to sell the MBS and they have to sell at a big loss (which they’ll heap onto the deficit – thank you taxpayers) then they won’t be able to take much money out of the system I believe. If the bad debt goes into the deficit, the the government will have to issue more debt and if private savings isn’t enough to absorb it, then the Fed will actually have to step in and monetize that debt and create MORE inflatioinary pressure. All of this is really currency debasement and not inflation per se. If it wasn’t illegal to reject USD for payment of goods & services and to accept a competing currency (gold for example), then there would be no actual inflation. But this is the system we bought when we went to a pure fiat currency system. In the long run it is unsustainable.
It’ll be fun to watch what happens to inflation over the next few years. I believe the Fed will attempt to let it run a little hotter than normal - say 4-5% - to help inflate our way out of debt. Then, in typical Fed form, they won’t be able to rein it in and we’ll have a serious problem. Also, I think we’ll see pretty serious inflation without home prices appreciating. It’s not a requirement.
jbaldyga Wrote: ------------------------------------------------------- > I don’t think there are enough UST debt holdings > to fully fight inflation. If they try to sell the > MBS and they have to sell at a big loss (which > they’ll heap onto the deficit – thank you > taxpayers) then they won’t be able to take much > money out of the system I believe. If the bad > debt goes into the deficit, the the government > will have to issue more debt and if private > savings isn’t enough to absorb it, then the Fed > will actually have to step in and monetize that > debt and create MORE inflatioinary pressure. > > All of this is really currency debasement and not > inflation per se. If it wasn’t illegal to reject > USD for payment of goods & services and to accept > a competing currency (gold for example), then > there would be no actual inflation. But this is > the system we bought when we went to a pure fiat > currency system. In the long run it is > unsustainable. If they sell it at a big loss, then that means prices are dropping = there is no inflation. If the fed has created inflation artificially by pumping money into the system, then it’s always possible to reduce it. "If the bad > debt goes into the deficit, the the government > will have to issue more debt and if private > savings isn’t enough to absorb it, " I have no idea what this means…
Palantir Wrote: ------------------------------------------------------- > If they sell it at a big loss, then that means > prices are dropping = there is no inflation. If > the fed has created inflation artificially by > pumping money into the system, then it’s always > possible to reduce it. if they sell at a big loss then they are extracting less money from the system than they originally put in --> too many dollars in the system = inflation. the whole point is that it’s not possible to reduce the money supply because they don’t have enough treasuries to sell in the open market. The Fed’s P&L goes to the treasury. So if there are losses, it gets heaped onto the deficit…unless taxes are raised. that should be an easy sell to the taxpayer. “your taxes are going up because we bailed out Wall St. and now you have to absorb their losses.”
Yeah but if they’re extracting less money, that means price level has dropped. If price level has dropped, how could the US be in an inflationary scenario? I think you’re thinking of hyperinflation, which would be a different scenario from simply high inflation.
why are you linking the “price level” to the value of the MBS they’re selling? Are you talking about prices in general? If so, i don’t think that’s necessarily true, especially considering that a lot of what the Fed took off private balance sheets was worthless (or close to it) at the time they bought it.
Generally speaking, we could probably assume if the price of the bonds on the Fed’s balance sheet has dropped, then rates have risen. If rates have risen then it’s also probably safe to assume inflation, or at least inflation expectations, is also on the rise. IMO, it’s still a weak link a best. Inflation is too ubiquitous to focus just on the MBS held by the Fed.
Sweep the Leg Wrote: ------------------------------------------------------- > Generally speaking, we could probably assume if > the price of the bonds on the Fed’s balance sheet > has dropped, then rates have risen. If rates have > risen then it’s also probably safe to assume > inflation, or at least inflation expectations, is > also on the rise. > > IMO, it’s still a weak link a best. Inflation is > too ubiquitous to focus just on the MBS held by > the Fed. Here’s how I see it: - The Fed’s main concern right now is not inflation, but deflation. - The main economic area deflating is residential real estate. - The bubble has popped, yet RRE prices are still in freefall despite reverting to fair or even cheap levels in most parts of the country. - These price corrections are overdone and damaging the overall economy, particularly the suburbs and middle class. - By buying RMBS, the Fed hopes to stimulate the root cause – residential real estate – directly. While I like the idea (given there is a Fed and given they intervene in the markets), there is risk that this could all go wrong. RMBS prices and interest rates are not perfectly correlated. Btw, the target interest rate is 20-30 years out on the curve. Question: what’s the duration of an average MBS? Hint: it’s not 30 years. Edit: I accidentally a word.
This isn’t in response to anyone, just something I find interesting… Home prices aren’t reflected in CPI. Shelter is the biggest component of CPI, but that’s based off of Owners’ Equivalent Rent. While home prices have fallen about 6% YoY, the Rents component of CPI has actually increased over 1%. Just a quirk in the awesome calculation that is the CPI, not a commentary on the effect of home prices on inflation.
^yea i think the imputed rent for homeowners is calculated off of market rents for actual rental units (which is a relatively healthy market because of the drop in the ownership rate). it was the opposite phenomenon in the mid 2000s. CPI was fairly tame even though home prices were skyrocketing because rental rates were relatively tame. There’s a million issues with the way CPI is calculated.
justin88 Wrote: ------------------------------------------------------- > Here’s how I see it: > > - The Fed’s main concern right now is not > inflation, but deflation. > - The main economic area deflating is residential > real estate. > - The bubble has popped, yet RRE prices are still > in freefall despite reverting to fair or even > cheap levels in most parts of the country. > - These price corrections are overdone and > damaging the overall economy, particularly the > suburbs and middle class. > - By buying RMBS, the Fed hopes to stimulate the > root cause – residential real estate – > directly. This gets it about right I believe. There is no functional limit to how much the Fed can buy or sell, though obviously inflation could get out of hand if they try to buy too much. Someone said something about running out of treasuries to sell which is ridiculous. Treasuries are a monetary instrument and the Fed can always provide any amount of securities that pay any interest rate it desires in order to absorb excess liquidity. > While I like the idea (given there is a Fed and > given they intervene in the markets), there is > risk that this could all go wrong. RMBS prices > and interest rates are not perfectly correlated. I don’t think I understand what you mean about the risk. The main risk with this sort of unconventional monetary policy changes expectations in some way that damage the economy. If the Fed wants interest rates to be somewhere, they will be there. > Btw, the target interest rate is 20-30 years out > on the curve. Question: what’s the duration of an > average MBS? Hint: it’s not 30 years. > > Edit: I accidentally a word. 15 years or something like that? Not sure exactly. If interest rates do reverse their downward course as they did in the early 1970s then that average MBS duration is going to be pushed out quite a bit.