Saturday, March 9, 2013

The Fed May Not Sell Assets?

This is a shocker:

The Federal Reserve is considering jettisoning a plan to eventually sell off the massive haul of bonds it is now buying…Fed officials have said they could simply allow the trillions of dollars in securities they have bought through three rounds of quantitative easing to mature.

Did anyone ever really believe otherwise? 

Fed Chairman Ben Bernanke and other officials have said a decision not to sell the mortgage and Treasury bonds would only add about a year to the process of returning the central bank's balance sheet to a more normal size of around $1 trillion, probably around 2020. It is worth some $3 trillion now, and could swell to near $4 trillion by year end.

Bernanke and the Fed didn’t see 2008 coming even in 2007.  But now he can forecast the Fed’s balance sheet seven years into the future?  And he believes the balance sheet will shrink?  And what is “normal” about $1 trillion?

Rest assured, absent outright default by the US Government, the Fed’s balance sheet will never again see a number approaching $1 trillion…or $2 trillion…or…. The Fed’s balance sheet will never shrink absent minor fluctuations and absent the aforementioned possibility (or likelihood) of default.

Not only has the central bank's balance sheet grown in value, but the average duration on the bonds has risen by 3 years to about 10 years. That means the Fed could suffer big losses on its portfolio later this decade if it sells assets when interest rates climb.

All those overeducated and overpaid economists at the Fed only now figured this out? 

A decision not to sell bonds, especially if stated forcefully by the Fed, would be stimulative both now and in the future because longer-term expectations about how many bonds will be in the market can effect the current pricing.

Theoretically, it could also allow the Fed to curb its current bond buying earlier than planned, or raise rates sooner.

That is one more theory that will not work out in practice.

Michael Feroli, chief U.S. economist at JPMorgan, said the benefits of a "no asset sale" policy are compelling enough that there is a good chance the Fed will adopt it.

"I'm not sure when we will see a new exit strategy," he added, "but I wouldn't be surprised to see one by June."

The chief JP Morgan economist.  I guess that seals the deal.

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