How Much New Quantitative Easing? Perhaps Less Than Jeffrey Rosenberg Estimates

Reprinted with permission from

Bank of America’s Jeffrey Rosenberg estimates that $340 billion of the Fed’s $2 trillion portfolio will roll off off the Fed’s System Open Market Account portfolio over the next twelve months, including $62.4 billion in Treasury debt and $46.9 billion in Agency (Freddie/Fannie) debt.  However, for purposes of determining effects on future open market operations — when the Federal Reserve Bank of New York transacts with its eighteen primary dealers — this is a bit misleading.

The Fed is already authorized by the Federal Reserve Act to replace maturing issues by purchasing directly from the issuer.  In fact, the Fed stated:

On August 10, 2010, the Federal Open Market Committee directed the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York to keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities (agency MBS) in longer-term Treasury securities.
Accordingly, maturing Treasurys and Agencies should not be included in the total. Principal payments on Agency debt of $159.4 billion with an average weighted coupon of 3.80% equals $6.0 billion over the next year, which is peanuts at the Fed level.  Cash flows from the Fed’s mortgage backed securities (MBS) will be the biggest contributor and must be estimated because they vary with interest rates.
An analysis of an admittedly small sample size of MBS factors of the Fed’s actual MBS holdings suggests that payments will be 15.3% over the next year. If interest rates were to stay constant (which of course they won’t), this would equate to $170.9 billion. If interest rates continue to go down, the amount increases, if they rise, the amount decreases. Also, if Freddie and Fannie started realizing losses and paid off defaulted securities, this number could explode. However, ceteris paribus, the Fed’s new Treasury purchases will be $176.9 over the next year, or $14.7 billion per month–about half of Rosenberg’s estimate.
As Robert Wenzel points out on EPJ Central, Treasury QE has a different effect than MBS QE, and we verified this in 2009 by observing a very high correlation between stock market ramps and Treasury purchase days in Q2 and Q3 2009. Most likely, the primary dealers will funnel this into proprietary trade positions.
Will $14.7 billion a month have the same effect as last year? All we know is that it will find a home somewhere –perhaps where we least expect it.
Update 8-12-10: First month’s purchases will be $18 billion and start next Tuesday, wherein it looks like the Fed will concentrate on buying 5’s and 7’s.