Thursday, December 16, 2010

Long-Term Yields, the Fed and QE2: The Weekly Fed Data

The 10-year United States Treasury issue backed off somewhat today. At 4:00 pm in New York the bond yielded about 3.43 percent, up from about 3.23 percent last week at this time. On Wednesday December 15, these bonds yielded around 3.55 percent, up from the previous Wednesday close of 3.30 percent.

Both Martin Wolf at the Financial Times and Jeremy Siegel, of the Finance Department at the Wharton School, in the Wall Street Journal attributed this rise in interest rates to the strengthening of the economy, which they both took as a good sign.

Although I hear their arguments, I am not quite convinced. This year, the yield on this 10-year security fell from a range of 3.80 percent to 4.00 percent in the March/April time frame. This fall in rates was attributed to the financial turmoil going on in Europe.

As can be seen in the chart, the rate feel almost constantly until late August. And, what happened in late August? Ben Bernanke spoke about QE2 at a Federal Reserve conference in Jackson Hole, Wyoming and guess what? The yield on the 10-year bond started up immediately and has continued to rise ever since. The timing of the rise was very specifically connected with the Bernanke speech and subsequent Fed releases. Where did the strength of the economy come into play? Wolf and Siegel just aren’t convincing.

So, the long term bond yield is rising. This isn’t what was supposed to happen. So the Federal Reserve got active. I reported this last Thursday evening as soon as the Fed statistics were released. (See

Here is a part of what I said, “The Federal Reserve added over $32 billion in Treasury notes and bonds to its portfolio from Wednesday, Dec. 1, to Wednesday, Dec. 8. This move was not to replace mortgage backed securities as was the case over the past few weeks.
Also, this increase was not to replace reserves lost through operating transactions. Quite the contrary, deposits with Federal Reserve Banks other than reserve balances, which includes the General Account of the U.S. Treasury, fell by almost $8 billion, which also added reserves to the banking system.

All-in-all, over $50 billion was added to Reserve Balances with Federal Reserve Banks over the past week. Most if not all of this will show up in Excess Reserves at commercial banks.”

This week the Fed bought more United States Treasury securities, but this time the purchases were a substitution for the securities that were maturing in the Fed’s portfolio of mortgage backed securities. The Fed purchased outright $18 billion in United States Treasury securities. This went to offset a decline in the mortgage backs securities of almost $14 billion.

Net, the Fed supplied reserve funds in the amount of $3.5 billion. (The figures don’t match exactly because of other small changed that took place in the balance sheet.)

An interesting aberration took place in the data released at 4:30 PM today. The Fed statistics show that the “average” increase in the United States bond portfolio for the week was $23.6 billion and the decline in mortgage backed securities was $2.0 billion. These figures differ from those given above because the figures above relate to the Fed’s balance sheet as of the close of business on each Wednesday. The figures reported in this paragraph relate to the average of daily figures for the week ending each Wednesday. The only thing that can be said about the two sets of figures is that most of the purchases of Treasury securities for the week ending December 8 must have come on Monday, Tuesday, or Wednesday of the week so that the weekly average was closer to the portfolio held for the week ending December 2. That is why the numbers relating to the weekly average are so large relative to the end-of-week numbers.
Reserve balances with Federal Reserve Banks, a proxy for commercial bank excess reserves, fell by about $64 billion during the week. The primary cause of this was an increase in the general account of the Treasury held at the Federal Reserve. These Treasury deposits rose by $72 billion during the week as the Treasury sent out checks to the private sector and withdrew funds from the government Tax and Loan accounts held at commercial banks.

This movement between accounts was purely an “operational” transaction and should not be considered a part of the QE2 process.

So, the conclusion for the week is that Federal Reserve open market operations for the week were primarily a substitution of United States Treasury securities for maturing mortgage backed securities. Thus, it seems that very little effort was put into trying to keep interest rates from rising.

The 20 to 25 basis point rise in the yields, seemingly, were not resisted by the Fed.

No comments: