It’s not just the Fed: what you need to know about Treasury tapering.


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U.S. Treasury Secretary Janet Yellen testifies before a Congressional committee in Washington.

Al Drago / Pool / AFP / Getty Images

Bonds are the only crop that never fails, according to the old saw recited by Chicago futures market traders when contracts were traded in a scrum rather than on a screen.

But the supply of new notes and bonds sold by the Treasury will shrink as demand from its biggest buyer, the Federal Reserve, is also expected to decline, as this column previously reported.

Wednesday will bring important announcements from both. In the morning, the Treasury’s quarterly repayment announcement will present its borrowing plans. The Federal Open Market Committee will release its policy statement at 2 p.m. EDT, which is widely expected to include the long-awaited announcement that it is slowing down its current securities buying program, which includes $ 80 billion in treasury bills and $ 40 billion. dollars in agency mortgages. backed securities.

“We are waiting [Treasury] Emissions decrease “coincidentally” on the very day the Fed announces the cut, “writes John Briggs, global head of NatWest office strategy.

In the very near term, the Treasury announced Monday that it would increase its borrowing to more than $ 1 trillion in the current quarter, from $ 673 billion in the previous quarter. This assumes, however, that the federal debt ceiling is lifted or suspended, which would allow the Treasury to borrow to replenish its cash balance to $ 650 billion. Getting the debt ceiling raised by Congress isn’t a sure thing, and perhaps the federal government may be able to cringe if tax revenues exceed expectations. Thus, the loan may not achieve this goal.

But beyond these political quarrels, economists forecast a sharp reduction in the budget deficit for the current fiscal year with the end of massive stimulus measures to combat the economic effects of Covid-19 enacted during the fiscal year ended. September 30.

Wells Fargo Senior Macro Strategist Mike Schumacher projects a fiscal 2022 deficit of $ 1.3 trillion, down sharply from $ 2.8 trillion in fiscal 2021. “In our opinion, reducing Treasury supply has received too little market attention, ”he wrote in a research note. .

Even the passage of the budget reconciliation bill, still contested by Congressional Democrats, would not materially affect this forecast. Most of the spending, which totals $ 1.7 trillion in its current version, would be spread over 10 years.

As a result, Schumacher sees the Treasury supply falling faster than the Fed’s purchases. It predicts that issuance of notes and bonds will fall to $ 1.7 trillion in fiscal 2022, from $ 2.8 trillion the year before. This would outweigh his projection of a $ 740 billion drop in Fed purchases of treasury bills.

The central bank is also expected to cut back on MBS agency purchases, which has helped fuel a housing market that is already seeing double-digit price increases that have excluded many potential first-time buyers. But even if the Fed gradually reduces its purchases of MBS by mid-2022, bond strategists at JP Morgan expect the central bank to remain an active participant in the sector.

The Fed will still reinvest between $ 50 billion and $ 60 billion in principal and monthly interest from its $ 2.5 trillion MBS portfolio, JPM strategists write in a research note. This rate of reinvestment would slow if mortgage rates were to rise, which would reduce the repayment of outstanding mortgages as the incentive to refinance wanes.

In classical analysis, the simultaneous reduction in the budget deficit would exert a budgetary brake on the economy at the same time as monetary policy becomes less accommodating due to the reduction in the growth of the Fed’s balance sheet. What’s more, once the Fed completes its cut, markets expect it will double its target for the fed funds rate in quarter-point increments.

But the Fed’s balance sheet, at $ 8.5 trillion, would remain more than twice as large as before the pandemic measures of March 2020. Two federal funds rate hikes would only push the key rate down a range. current from 0-0.25% to 0.50% -0.75%. Meanwhile, the budget deficit would still be 7% of GDP with an economy close to full employment.

In other words, this is not a repeat of 1937, when a sudden and simultaneous shift towards restrictive monetary and fiscal policies led to the second phase of the Great Depression. This would be a normalization of previous emergency policies as a recovery takes hold and inflation looks more intransigent than transitory.

Write to Randall W. Forsyth at [email protected]

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