Jerome Powell’s “QE Lite” preview, delivered on Tuesday in Denver, suggests the Fed will attempt to rebuild a reserve buffer rapidly, Goldman says, in a new note updating their projections for balance sheet expansion.
Perhaps the most notable bit from Powell’s remarks in Colorado was the allusion to buying T-bills.
It revealed a bit about the operational details behind the upcoming purchases and also indicated that policymakers viewed last month’s repo dramatics as at least in part a function of too much supply (i.e., too much collateral, and not enough cash) as Treasury looks to finance the ballooning US budget deficit.
For Goldman, that signals a desire to address reserve scarcity sooner rather than later.
“Importantly, by mentioning ‘the purchases of Treasury bills we are contemplating’ (which we interpret to mean both T-Bills and short coupons), Powell implied that the FOMC is willing to use a different composition of purchases to engineer the needed shift upward in the level of reserves”, the bank says, in a note dated Wednesday. “This, in turn, suggests that Fed officials would prefer to complete the adjustment quickly, rather than using the more gradual schedule we had previously assumed”.
What, exactly, does that entail?
Well, for Goldman, it means that the Fed will buy an additional $60 billion in securities a month over four months, across bills and short coupons. That is, of course, on top of the $20 billion/month run rate to replace the MBS paydowns.
“In addition to the resumption of trend balance sheet growth… our base case is that the Fed will engineer a one-off level shift of roughly $200 billion over the course of four months”, Goldman says, referencing the first four grey bars in the chart. “This should return reserves to a level where they are truly ample, allowing the Fed to cease relying on temporary open market operations as a regular tool”, the bank adds.
Here’s a snapshot of the TOMO topography (if you will) after nearly a month of operations:
For his part, BofA’s Mark Cabana sees the initial pace at $50 billion/month. “We had originally assumed the Fed might target its purchases solely in the bill market which led us to believe the Fed might only be able to buy $25 billion/month [but] after conducting [a] maximum purchase analysis we could see a case for the Fed to purchase $50 billion/month concentrated in the bill and 0-3Y coupon sector”, he wrote Wednesday.
The problem with the above is obviously that additional purchases of $50 or $60 billion in securities per month will make Powell’s “in no way is this QE” line hard to swallow for some market participants, especially considering how that stacks up to the size of the ECB’s new QE program, although we would argue that anyone who is savvy enough to make that comparison would almost by definition understand why “organic” balance sheet growth is not QE and why the the Fed needs to front-load the effort to return to an ample reserves regime with a buffer ahead of the year-end funding squeeze.
One possibility is that the Fed goes big in November and December and then backs off once the calendar flips.
“A faster pace prior to year end would help the dealers better manage their balance sheets leading into the year end GSIB reporting date and the slower pace of purchases after year end would help guard against the perception that these purchases are indeed QE”, BofA’s Cabana said Wednesday, after cautioning that irrespective of how hard Powell tries, and notwithstanding the fact that anyone who cares enough about this to pay attention to the pace of purchases should know better, “the Fed will have a challenging time distinguishing these permanent open market purchases from QE”.
And then there’s the assumed rate cut later this month to factor in. That could make the optics even more challenging for a Fed that wants to push back against the idea that balance sheet expansion always equates to QE.
“Communications may be further complicated by the fact that the market now largely expects the FOMC to lower the fed funds target range by 25 bps at the October FOMC meeting”, Cabana goes on to write, adding that “announcing permanent balance sheet growth while lowering interest rates risks being confused by some market participants as QE”.
Incidentally, from a market function perspective, BofA says up to $50 billion in purchases per month likely wouldn’t adversely affect liquidity.