As “The Dreaded Taper” has become ‘the next big thing’ for the media and something for the media to obsess about (btw we called this shortly after “the dreaded sequester” turned out to be not-so-dreadful–see session 15), I thought it appropriate to do a session to frame this horrific problem. I hope it keeps you off the ledge and somewhere cool and collected in this long (maybe hot) summer of 2013.
Here is how I see things.
First of all, when we have this dreaded taper event, it will be a good thing. It will mean we have survived the worst financial crisis in modern times and the economy is on the way to a healthy recovery. As a normal consequence interest rates will move back up. Interest rates moving back up will not have to mean that the economy will be choked off, because they will be coming from QE and fear driven (mostly fear driven), low levels.
Now, there are a many people who worry about how you stop and reverse the massive program called QE. I mean the Fed buying $85 billion a month in longer-maturity treasuries and agency mortgage-backed securities is nothing to sniffle at. Then, again, maybe it is.
For the record U.S. Treasury debt now stands at somewhere over 16 trillion dollars. Agency MBS (mortgage-backed securities) have a current outstanding principal balance of 5.6 trillion dollars. For a detailed look at these markets we have attached a link to SIFMA statistical web page.
The Fed is buying $85.0 billion of intermediate to longer-term treasury securities and agency MBS per month, about $4.0 billion per day split evenly between the two classes. Meanwhile the Treasury is issuing $40.0 to $45.0 billion per month in new debt. Ergo, it can be said that the Fed is buying everything that Treasury is selling at a rate of $2.0 billion per day. However, there is an active market in U.S. Treasury securities averaging trading volume over $500 billion per day. As to the agency MBS part of the equation, that market trades over $250 billion per day on average. The $2 billion going into this sector, again, is less than 1% of total volume. Against the backdrop of both markets $4 billion QE per day seems rather paltry.
Said another way, QE at $4 billion per day represents little more than 1/2 of 1 percent of incremental demand for longer-term government and agency MBS securities. It sounds like a big number, but in the context of a nearly $22 trillion combined market value and $750 billion combined daily combined trading volume, it is not.
If QE is withdrawn at the same pace that it was applied it will represent little more than half of one percent of incremental supply to the daily trade. This would seem to be the impending disaster that we will be faced with. To be sure rates will rise, and for all the right reasons, a stronger economy and a lessening of the fear that would lead an individual or institution to accept a 1.6% on a ten year note to get absolute guaranteed safety.
Now, there are those that will claim that higher rates will kill the economy, especially housing. In my lifetime people have bought homes with 9%, 10% even 12%+ mortgages. If a willing buyer has confidence it the economy, a 5% or 6% 30-year mortgages will looked like a good deal (one can always refinance if rates go down). Higher rates may also deter the formation another bubble.
With the Fed Open Market Committee meeting this week the noise and speculation vis a vis the end of QE will continue and the market may continue to correct. In my opinion it will continue to just be “noise” and not good reason to part company with a portfolio of good businesses.
What do you think?
PS. This morning (Monday June 17, 2013), before I shot session 41 off into cyber-space, I saw a front page article in the Wall Street Journal by John Hilsenrath ,”Economists Wary As Fed’s Next Forecast Looms.” Hilsenrath makes the point that we should not worry about the end of QE in the short-term, because Fed economic forecasts tend to be too optimistic. As the data has come in at lower levels than their expectations, the program will be continued. This may be true in the short-run. My post today, hopefully, will provide constructive thought process in case Mr. Hilsenrath is wrong.
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