“It Will Be Quite Ugly” As Fed Ignores Looming $4 Trillion “Big Policy Mistake”

Thursday, November 8, 2018
By Paul Martin

by Tyler Durden
ZeroHedge.com
Thu, 11/08/2018

Last week we reported that after some $34 billion in Treasury and MBS maturities on October 31, the Fed’s balance sheet had shrunk the most ever in one month since the start of the Fed’s quantitative tightening, as the Fed’s holdings of Treasurys, MBS and other assets declined to “just” $4.14 trillion, down 7% from their all time highs of $4.5 trillion one year ago.

And it is this decline that is now spooking Wall Street, with a Bloomberg report citing Fixed-income traders who are “telling the Federal Reserve that it might end up making a big policy mistake.”

While most pundits have been concerned about the Fed ongoing rate hikes and resulting tightening in financial conditions, as the Fed’s balance sheet unwind has picked up, “unexpected knock-on effects” have emerged in overnight lending markets such as IOER, Fed Funds and, of course LIBOR -which just hit a new decade high – where demand for short-term cash has been on the rise again after a sharp spike earlier in the year.

The argument is that the Fed’s balance sheet shrinkage is increasingly threatening financial stability, resulting in quotes such as this one from TD Securities rates strategist Priya Misra: “The Fed is in denial. If the Fed continues to let its balance-sheet runoff continue, then reserves will begin to become scarce.

They will become even more scarce if the Fed continues unwinding its balance sheet at the current “cruise control” speed of $50BN per month. If the Fed maintains the current pace through the end of next year, its assets would fall to about $3.7 trillion from $4.1 trillion today (and a high of $4.5 trillion), resulting in even more distortions in overnight funding markets.

Which, taken on its face, is bizarre: while the Fed’s excess reserves with banks currently amount to just over $1.7 trillion, this number was just $50 billion, give or take, before the crisis.

The Rest…HERE

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