With the media maintaining their glare on Donald Trump’s every move, the Federal Reserve continues to run off assets from its balance sheet. Last week the balance fell to $4.319 trillion – down $141 billion since the reduction scheme was announced by former Fed Chair Janet Yellen in September 2017. $88 billion has been in treasury securities, whilst $36 billion has come in mortgage backed securities.
Wolf Richter at WolfStreet.com is one of only a handful of economists that post regular updates on the Fed’s balance sheet ‘normalisation‘ programme. In his latest article, he makes the salient point that when the Fed rolls off assets, the U.S. treasury department hands the Fed the money for the assets to which the central bank then destroys. In other words, the Fed are draining liquidity from the financial system by reducing their balance sheet. Bare in mind also that the money they are destroying is the same money that was originally created to purchase securities during quantitative easing post 2008.
As Richter explains, the media celebrated quantitative easing when it was first launched as a mechanism for rebuilding ‘stability‘ in the market place. As misguided an assertion this was, they are giving no sustained coverage now that the Fed are unwinding their QE programme. In Richter’s words, they are ‘silencing it to death.’
The one exception has been Gillian Tett at the Financial Times. In an article dated June 7th 2018 (Watch the Fed’s balance sheet, not interest rates), she explains that as the Fed have been unwinding, the Trump administration has been issuing a record amount of bonds into the market place to raise capital for increased government expenditure, and also because of recent tax cuts administered by Trump resulting in a reduction of government revenue. According to Tett, over $2.3 trillion of treasuries will be sold over the next two years.
Here is where Tett’s analysis gets interesting:
- Global investors will need dollars to buy those bonds. However, the rub is that the Fed’s unwinding is sucking dollars out of the system, currently at a pace of $20bn a month, which is slated to rise to $50bn next year (or a cumulative $1tn of liquidity by December 2019.) That creates a dollar liquidity squeeze.
Tett cites concerns raised by Urjit Patel, the governor of the central bank of India. Earlier this month Patel argued that dollar funding in emerging markets is experiencing severe turbulence, for which he holds the pace of the Federal Reserve balance sheet shrinkage as responsible. He wants the Fed to change course and reduce asset holdings more slowly. The crux of Patel’s position rests on the understanding that as the net issuance of debt by the U.S. government rises, the Fed’s balance sheet reduction will also rise. So the government takes on more debt as the Fed persist in removing billions of dollars from the system.
Patel, however, does not put any of this down to malevolent intent on behalf of the Fed. Instead, he refers to it as ‘unintended coincidence‘. This is a default position amongst mainstream analysts. If the behaviour of governments or central banks cannot be reasoned as coincidence, then the next step is to refer to it as incompetence. Never is the suggestion of a conspiracy brought into the conversation.
Tett concludes her piece with this warning:
- The main conclusion for investors is that they should heed Mr Patel and recognise that interest rates are not the only game in town. They need to watch to see what the Fed does (or does not) do next with that balance sheet. And while Mr Patel is entirely correct to suggest that the Fed needs to take Mr Trump’s tax cuts into account, and consider tweaking policy, I would not bet many dollars (or rupees) that the Fed will ever publicly accept his plea. Investors in emerging market assets should be warned.
Prior to Janet Yellen leaving the Fed, she made it expressly clear that they would only consider a renewal of asset purchases in the event that the Fed began cutting interest rates. So far, Jerome Powell has said nothing to contradict this position and there is no indication from Fed communications that they intend to.
As the balance sheet reduction grows, and the Trump administration generates trillions more dollars in new debt, something will eventually break. One thing for sure is that when it does, it will not be the Fed that takes responsibility. Geopolitical events will conspire to place the burden of blame on the actions of Donald Trump.
A potential sign of what might be to come brings Russia and China into the mix. China is actively taking steps to detach itself from the hegemony of the U.S. dollar. The Shanghai International Energy Exchange has now introduced crude oil contracts priced in the Reminbi (dubbed the ‘Petro-Yuan‘). Meanwhile, Russia is also seeking to become independent from the Dollar. Last month Vladimir Putin said this:
- Oil is traded in dollars on the exchange. Certainly, we are thinking about what we need to do in order to get free of this burden. The whole world sees the dollar monopoly is unreliable; it is dangerous for many, not only for us.
- This is not merely a separation from the dollar; this refers to the need of strengthening our economic sovereignty.
The dollar as world reserve currency is dependent on the dollar being the choice of payment for global oil contracts. If this is challenged over the coming months and years, the dollar will suffer not only an extreme devaluation, but it will also generate the conditions for hyper inflation. The end result would likely be a loss of the dollar as world reserve.
Another important factor is China’s holding of U.S. debt, which as of April was reported as being $1.18 trillion. A pending trade war with America’s biggest trading partner could prove to be a catalyst for China dumping U.S. treasuries, further eroding the dollar’s hegemony. A breakdown in the current overtures of ‘peace‘ between the U.S. and North Korea could also be a catalyst, given that China is the North’s closest ally.
The Fed have been propping up the U.S. economy ever since the start of their QE programme. That support is now being withdrawn at an increased rate, at a time when geopolitical tensions grow in stature.
- The Fed’s balance sheet for the week ending June 6, released Thursday afternoon, shows a total drop of $141 billion since October, the beginning of the era officially called “balance sheet normalization.” At $4,319 billion, total assets have dropped to the lowest level since May 7, 2014, during the middle of the “taper.”
- If the Fed continues to follow its plan, it will shed up to $420 billion in securities this year, and up to $600 billion a year in 2019 and each year in the future, until it considers its balance sheet to be “normalized” — or until something big breaks.
- Department store chain House of Fraser is to close 31 of its 59 shops, affecting 6,000 jobs, as part of a rescue deal.
- If the plan is approved, 2,000 House of Fraser jobs will go, along with 4,000 brand and concession roles.
- The stores scheduled for closure, which include its flagship London Oxford Street store, will stay open until early 2019, House of Fraser said.
- The G7 summit has ended in acrimony, with US President Donald Trump lashing out at host Canada and retracting his endorsement of the joint statement.
- He accused Canadian Prime Minister Justin Trudeau of acting “meek and mild” during meetings, only to attack the US at a news conference.
- The summit was dominated by disagreements, notably over trade.
- The proportion of Britons who think interest rates are likely to rise over the next 12 months has fallen, according to a Bank of England survey published on Friday.
- The BoE said 51 percent of people polled between May 4 and 8 — before the central bank’s policy meeting on May 10 — thought rates were likely to rise, down from 58 percent in February.
- Twenty-five percent said they had no idea how rates were likely to change over the next year — a record high.
- The inflationary impact of the slump in sterling after the 2016 Brexit vote was probably fading more quickly than the BoE had expected. But the sharp fall in unemployment in Britain would push up wages, Tenreyro said in a speech.
- “While I anticipate that a few rate rises will be needed, the timing of those rate rises is an open question,” she said.
- The European Union expects to hit U.S. imports with additional duties from July, ratcheting up a transatlantic trade conflict after Washington imposed its own tariffs on incoming EU steel and aluminium.
- EU members have given broad support to a European Commission plan to set 25 percent duties on up to 2.8 billion euros (2.4 billion pounds) of U.S. exports in response to what is sees as illegal U.S. action. EU exports that are now subject to U.S. tariffs are worth 6.4 billion euros.
- Despite a torrid start to 2018 and with Brexit uncertainties looming large, British blue-chip stocks have jumped to record highs thanks to a weak pound, a torrent of mergers and acquisitions, and bouts of political anxiety in the euro zone.
- The comeback has been driven, or at least accompanied, by a flurry of M&A activity. This has hit an all-time year-to-date record in 2018 with the total value of UK deals standing at just over $260 billion, according to data from the Thomson Reuters Deals Intelligence team.
- If current conditions persist, corporations are likely this year to inject more than $2.5 trillion into what UBS strategists term “flow” — the combination of share buybacks, dividends, and mergers and acquisitions activity.
- The development comes as companies find themselves awash in cash, thanks primarily to years of stashing away profits plus the benefits of a $1.5 trillion tax break this year that slashed corporate rates and encouraged firms to bring back money idling overseas.
- The UK government has cleared the way for Rupert Murdoch’s 21st Century Fox to buy Sky on the condition it sells Sky News to another organisation.
- It also approved a rival bid for the British broadcaster from US media giant Comcast, setting up a multibillion-pound bidding war.