Thursday, August 27, 2015

Rate Hikes and QE...Simultaneously?!? Actually, Yes!!!

We are in such uncharted waters that as the Fed readies to raise rates, the plan is that QE will continue alongside interest rate hikes. No, seriously. At the minimum, the Fed will continue to repurchase maturing bonds to maintain its $4.5 trillion balance sheet...aka buying bonds or QE.  So, if they can continue repurchasing while hiking rates, there really is no reason they couldn't increase their holdings (embark on QE4 or 5 or whatever it is now) simultaneously..."if economic conditions warranted"?!?

In the days before '08, to raise rates, the Fed would sell bills and bonds to banks, paid for from banks excess reserves, tightening available money for lending from excess reserves.  This would force overnight interbank lending rates higher and that would begin effectively filtering its way through market rates.  However, that was in the days when excess reserves held by banks were like $25 a little open market operation by the Fed to remove a couple billion here or there was all it took.  Now, banks hold something like $2.5 trillion in excess reserves. So, for the Fed to tighten overnight rates, the Fed would need to remove something like $2+ trillion to make any impact. Not gonna happen and Fed has admitted this.

That's why the "plan*" (* this has never been done and is totally theoretical) is to increase IOER's (interest on the excess reserves banks hold) so banks are de-incentivized to lend as they can get higher returns parking money at the Fed?!?

All sounds pretty non-sensical until you remember the Fed works for the banks...well, then it all makes perfect sense to pay banks billions more not to lend money while simultaneously increasing interest payments for those who do take loans? There are also all kinds of concerns what happens with money market or other "non-bank" funds that aren't eligible for IOER and what happens in times of high systemic stress.

Still, bottom line is nothing can be ruled out and the fact the Fed will continue to buy bonds while simultaneously raising rates...well, it's just a key-stroke away from increasing it's balance sheet and raising rates...a particularly important detail when some of the largest holders of US debt, China and Russia, are making it clear they are going to hold significantly less. 

Further details on Treasuries, Gold, and the dollar...