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September 18, 2017

The Federal Reserve began talking 8 years ago about liquidating the assets accumulated during “Quantitative Easing.”  The unique strategy designed in late 2008 by then Fed Chairman Ben Bernanke that involved the creation of new money used to purchase bonds did exactly what it was intended to do – keep the USA out of a depression by making the cost of money as cheap as possible.  Few people thought that QE would last as long as it did (6 years) or that the strategy would amass as many bond assets as it did ($4 trillion).  But finally, 3 years removed from the end of QE, the Fed has confirmed that they will begin the process of shrinking its balance sheet when the time is right, possibly as soon as this week.  How the domestic bond market reacts to the Fed’s action is the key storyline.  Unless another major bond buyer steps in to fill the void created by the Fed’s exit, interest rates for Treasuries could rise (source: BTN Research).

Through 11 months of fiscal year 2017 (i.e., through 8/31/17), the US government has accumulated a $674 billion deficit.  Since September is typically a surplus month (due to the payment of estimated taxes by small business owners), the final deficit for FY 2017 may finish close to the $587 billion deficit from FY 2016 (source: Treasury Department).

The artificial constraints the Treasury Department had been utilizing for the last 6 months to hold our national debt at $19.8 trillion are now suspended through Friday 12/08/17.  This has allowed our country’s debt to climb to $20.2 trillion last week.  10 years ago today (9/18/07), our national debt was $9.0 trillion (source: Treasury Department).

 

Notable Numbers

SIX YEARS, THREE ROUNDS – Overall, “Quantitative Easing” (QE) ran for 6 years over 3 different programs.  QE # 1 began on 11/26/08 and QE # 3 ended on 10/29/14 (source: BTN Research).

SIZE OF EACH – QE # 1 purchased $1.725 trillion of debt, QE # 2 purchased $600 billion of debt, and QE # 3 purchased $1.7 trillion of debt.  In total over 6 years, all 3 rounds of QE purchased $4 trillion of Treasury debt, mortgage-backed securities and Fannie and Freddie debt (source: BTN Research).

BUBBLE? – The historically low interest rates created by QE may have played a part in driving investors to higher yielding and higher risk investments, e.g., the S&P 500 began its 8 ½ year bull market run on 3/09/09, just 3 ½ months after QE # 1 began (source: BTN Research).

OTHER BUYERS? – As the Federal Reserve shrinks its $4.2 trillion balance sheet, another buyer could step in to fill the void.  As of June 2017, China ($1.15 trillion) and Japan ($1.09 trillion) are the 2 largest foreign holders of US treasuries (source: Treasury Department).

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