Fed getting into the treasury markets

[808shooter]

Just learned something this week that has been bothering me.

The Fed has recently had a change in fiscal policy where it will now be trying to affect long term rates by buying 10 year US Treasuries on the open market.

Historically the Fed has been content to set monetary policy by setting short term rates via the fed funds rate. Long term rates have always been established by market forces.

This is big.

????? Where is the front page news?

This seems like a huge policy shift. Inflationary concerns anyone?

Potential abuse of Presidential and Treasury powers to encourage irresponsible federal spending?

Are our financial editors at the Star Bulletin or Advertiser asleep at the wheel? Not to mention journalists at other major news orgs. Am I overreacting?

Here is an article I found googling.

http://www.forbes.com/2009/04/02/tre...ry-bubble.html

[Nords]

Re: Fed getting into the treasury markets

The Fed has recently had a change in fiscal policy where it will now be trying to affect long term rates by buying 10 year US Treasuries on the open market.
Historically the Fed has been content to set monetary policy by setting short term rates via the fed funds rate. Long term rates have always been established by market forces.
This is big.
????? Where is the front page news?
This seems like a huge policy shift. Inflationary concerns anyone?
Am I overreacting?

Bernanke's mentioned it in speeches/testimony several times going back up to a year, referring to his intentions to use "all the tools at the Fed's disposal". I remember noticing it in Reuters' financial news and seeing it on other financial-analysis websites like SeekingAlpha.

It is a policy shift, although it's an implementation of powers that the Fed has had for some time but never deemed necessary. Bernanke has taken the Fed's influence to places that Volcker & Greenspan never even dreamed of, and inflation is a big concern. But for some years now the Fed has been losing the ability to affect interest rates by the fed funds rate.

Perhaps it's not deemed worthy of interest to the general public, or maybe all the people who were aware of this have been refinancing their mortgages. (I keep thinking that rates can't possibly get any lower and I keep being proven wrong.) I didn't really pay much attention to it. A friend works at the New York Fed, though, and it's getting plenty of discussion on boards that analyze bond rates and Fed policies.

The Fed is rightfully concerned about inflation, but they're downright terrified by deflation. The data-analysis tools aren't precise enough to tell when the line has been crossed, so they'd rather put up with a weak economy & rising inflation than a dead economy & deflation. Heck, the tools might not even be accurate enough to tweak interest rates with much confidence.

Whatever the Fed's doing is having the intended effect. The mortgage business has exploded in the last couple months and Buffett's been referring to a huge bubble in Treasuries. We refinanced our mortgage and then I stopped paying attention to interest rates. And I don't have the motive (nor the guts) to short Treasuries. But if inflation indicators start taking off again, the Fed will probably try to ride the razor's edge between controlling inflation and letting the economy grow stronger. My guess is that inflation will be a lower priority than the economy.

Are our financial editors at the Star Bulletin or Advertiser asleep at the wheel?

Can't even tell that the local papers have financial editors...

[808shooter]

Re: Fed getting into the treasury markets

Bernanke's mentioned it in speeches/testimony several times going back up to a year, referring to his intentions to use "all the tools at the Fed's disposal". I remember noticing it in Reuters' financial news and seeing it on other financial-analysis websites like SeekingAlpha.

It is a policy shift, although it's an implementation of powers that the Fed has had for some time but never deemed necessary. Bernanke has taken the Fed's influence to places that Volcker & Greenspan never even dreamed of, and inflation is a big concern. But for some years now the Fed has been losing the ability to affect interest rates by the fed funds rate.

Perhaps it's not deemed worthy of interest to the general public, or maybe all the people who were aware of this have been refinancing their mortgages. (I keep thinking that rates can't possibly get any lower and I keep being proven wrong.) I didn't really pay much attention to it. A friend works at the New York Fed, though, and it's getting plenty of discussion on boards that analyze bond rates and Fed policies.

The Fed is rightfully concerned about inflation, but they're downright terrified by deflation. The data-analysis tools aren't precise enough to tell when the line has been crossed, so they'd rather put up with a weak economy & rising inflation than a dead economy & deflation. Heck, the tools might not even be accurate enough to tweak interest rates with much confidence.

Whatever the Fed's doing is having the intended effect. The mortgage business has exploded in the last couple months and Buffett's been referring to a huge bubble in Treasuries. We refinanced our mortgage and then I stopped paying attention to interest rates. And I don't have the motive (nor the guts) to short Treasuries. But if inflation indicators start taking off again, the Fed will probably try to ride the razor's edge between controlling inflation and letting the economy grow stronger. My guess is that inflation will be a lower priority than the economy.

Well this policy shift concerns me greatly. This is not just printing more money by issuing more t-bills. The market will influence the amount of Treasuries issued, the US Government can't kill the market by flooding it just to finance our deficit. But having the Fed buy treasuries on the open market is like giving the Obama and congress a blank check without restrictions. Or at least a heck of a lot less restrictions.

What exactly do you mean by the Fed has been losing the ability to affect rates via the fed funds rate? Doesnt' credit card debt and Arm rates still derived from the Fed funs rate?

Just asking because I'm curious, not challenging you.

[Nords]

Re: Fed getting into the treasury markets

Well this policy shift concerns me greatly. This is not just printing more money by issuing more t-bills. The market will influence the amount of Treasuries issued, the US Government can't kill the market by flooding it just to finance our deficit. But having the Fed buy treasuries on the open market is like giving the Obama and congress a blank check without restrictions. Or at least a heck of a lot less restrictions.

I don't follow the analogy. The Fed has had the tool, just not been using it. At some point Bernanke put away his hammer & chisel and reached for the 90-pound jackhammer. If he needs even bigger tools that he doesn't already own, then he's going to have to go ask someone (like Congress) for more money. And if you're concerned about the political issuse, then here's a slightly different perspective: if the choice of Treasury ownership comes down to Bernanke or the Chinese, I think I'd go with Bernanke.

I'm not concerned about the political issues. I'm concerned about the stupid issue. The Fed is buying Treasuries at a time when worldwide demand has never been higher. In fact demand at one auction within the last few months was so high that the yield was negative. It must've been like selling tickets for a rock concert. People were actually asking the federal govt to hold their money for them and take a little off the top for their trouble. Buffett was joking if another auction went like that then people were going to go shopping for bigger mattresses instead of Treasuries.

Frankly, I'm surprised. With all the worldwide trash-talking of the dollar, which as little as two years ago was trading at 25-year lows, it's still come roaring back. When the credit markets froze up, foreign investors didn't put their money in their own country's currencies or investments. They didn't buy renminbi, and they didn't even buy euros. They came in a thundering herd to buy dollars and Treasuries, no matter how much the Middle East and the Chinese sniveled about it. So apparently the citizens of other countries pay as much attention to their governments (elected representatives or otherwise) about as much as we do. Or else they have more faith in our government than we do, but perhaps they just have more faith in Americans to pay higher taxes.

What exactly do you mean by the Fed has been losing the ability to affect rates via the fed funds rate? Doesnt' credit card debt and Arm rates still derived from the Fed funs rate?
Just asking because I'm curious, not challenging you.

If a bank doesn't borrow the fed's money, or if they're getting 10x more money by borrowing it from another source, then it doesn't matter what the fed funds rate is. It's just a number, a reference point, printed in the Wall Street Journal (or the London Interbank Overnight Rate) that other banks use to set their own interest rates. The banks are the ones setting credit card & ARM rates, not the Fed.

Speculative investment banking has grown so big that the Fed became a minor player by comparison. When a banker could leverage 200:1 for almost nothing then there's not much the Fed can do by tweaking an interest rate.

It's hard to remember when the cost of credit has been lower. I was looking at our mortgage files the other night. When we bought our home at the pit of the Hawaii market, August 2000, our mortgage rate was 8.5% fixed for 30 years. That was the best interest rate available for borrowers who had the equivalent of 800+ credit ratings. Less than nine years (and four refinancings) later it's down to 4.5%. Our monthly payments have dropped by over a third. We had to work a little harder to get that rate, but it's the lowest mortgage rate that I've ever seen-- and probably lower than our parents have seen, too.

My friend at the NY Fed used to work for an institutional hedge fund in Greenwich that imploded last fall. The Fed was about the only one hiring...

[808shooter]

Re: Fed getting into the treasury markets

hey thanks for taking the time to respond so throughly.

that doesn't make any sense. Why would the Fed be buying treasuries if the demand for it was so high. What's the point? If they were trying to control long term rates, then why not do it when demand is low and they need to prop up the value?

negative yield at a treasury auction? man I am working too hard and missing out on all of this interesting news.

http://www.guardian.co.uk/business/feedarticle/8424059

dang you were right. negative yield . that is news. although it seems like it was a quarter end anomoly and the Fed thinks that it's far more likely that supply will spur yields.

http://online.wsj.com/article/BT-CO-...26-717652.html

to me it's amazing that now the world's three largest economies are now acting in concert to prop up the dollar. (and in the case of the US - control long term rates).

Although it's disturbing that the Chinese own so much of our national debt, it is currently only secured by our goodwill. If plans are put into place to secure the debt with hard assets, that would be concerning to me. Hear an rumours like that?

finally as to the fed funds rate not setting rates, I see what you mean. There are so many other ways to access large amounts of capital, the fed is not the only game in town.

cool this whole line of conversation has got me catching up with financial news for the next few days.

[Nords]

Re: Fed getting into the treasury markets

Although it's disturbing that the Chinese own so much of our national debt, it is currently only secured by our goodwill. If plans are put into place to secure the debt with hard assets, that would be concerning to me. Hear an rumours like that?

Interesting question. In the 1980s it seemed as if the Japanese were going to rule the financial world, and there were daily headlines of their asset purchases-- including the sale of Rockefeller Center and Pebble Beach. Kawamoto was only a small slice of the big swingin' buyers snapping up American real estate.

Then it was pointed out that the Japanese were only 21% of direct foreign investment in the U.S. The largest? The United Kingdom at 27%. But UK taking over the U.S. didn't seem to generate anywhere near as much publicity & hysteria. And then it all imploded after DESERT STORM, and today much of Japanse foreign direct investment has been sold back to Americans for pennies on the dollar.

Part of the problem is how the numbers are counted. For example, American debt is considered "public" (held by American citizens or foreign countries or foreign citizens) and "private" (held by the U.S. govt in one agency or another). "Debt" includes Treasuries as well as the bonds of FHLMC & FNMA, govt sponsored entities whose debt appears to be guaranteed by the U.S. (which is somewhat controversial) and might be a taxpayer responsibility as well. So depending on the point being made, the numbers can be manipulated broken down to make foreign holdings look bigger or smaller.

Last year the American gross debt was about $10.6 trillion. The Chinese hold about a trillion of that for roughly 10%. However "only" about $740B of that is in U.S. Treasuries (http://www.treas.gov/tic/mfh.txt) with the rest probably being Freddie Mac & Fannie Mae bonds (http://usbudget.blogspot.com/2009/03...-treasury.html).

This Wikipedia summary claims that 28% of the total public debt is held by foreign countries. Of that 28%, China holds roughly a quarter of it.

Finally, pages 30 & 31 of this PDF summarize foreign direct investment. That's the "hard assets" of U.S. land, factories, and other multi-national corporate businesses controlled by other countries. Like U.S. debt, FDI is probably subject to a wide range of interpretation and dependent on the point the interpreter wants to make. This table is also two years old and based on cost, not value, so it probably can't be directly compared to the gross debt numbers. But the point is the percentages: of the total 2007 FDI, over 70% of it belongs to Europe and the U.K. alone is 20%. Japan is down to less than 12%. China? About 0.05%. If China plans to trade in debt for hard assets then they have a lot of catching up to do.

My impression of the Chinese complaints about its $1T U.S. bond portfolio is an over-concentrated and greedily naive investor getting nervous and whiny. They vacuumed up billions of dollars in trade, redeemed those depreciating dollars for U.S. bonds, and now they're worried that the bonds are going down in value too. If they sell that debt, they're not going to get anywhere near what they paid for it. Their only options are the typical bondholder's dilemma-- continue collecting interest until the bond can be redeemed at maturity (possibly years later), or sell now for a big loss. Even worse, they snorkeled up a lot of the Fannie & Freddie mortgage debt and now they're finding out that they didn't really understand what they were getting into. They're learning the first rule of American capitalism: Suckers! Caveat emptor.

I don't think China or any other country's foreign direct investment is political or part of some dark global-dominance conspiracy. I suspect that foreign countries are investing in the U.S. (http://en.wikipedia.org/wiki/List_of...y_received_FDI) because... well... that's where the money is. The American stock market has been hot for most of the last three decades, taxes are relatively low, there's a relatively low degree of political/govt risk (compared to the rest of the world), and economic activity has been brisk.

In the big long-term perspective, I think that the last 65 years of American global dominance have been mainly due to being one of the few countries whose infrastructure and/or currency wasn't destroyed by world war. That economic "advantage" is just about gone, and we need to get over it. The American lead is probably diminished, although the Internet appears to be affecting our economic prospects as much as the railroads affected 19th-century American expansion. (Too early to make a definite conclusion about that yet.) But the mechanisms are still in place and can still persist well into the 21st century.

Two of the best and most readable books I've ever enjoyed on the history of world trade and global prosperity are William Bernstein's "The Birth of Plenty" and "A Splendid Exchange". (http://www.efficientfrontier.com/) Even if America is on the decline, it's still far better than it used to be and it's a slow change.