Quantitative operations in US

a look at tightening or easing activities by the FED

is the FED giving liquidity to markets?

Weekly Flows:

• the FED is running quantitative easing right now
• it has added liquidity tobond markets for a total of USD 7.0bn last week, after adding USD 15.0bn the week before
• the rolling 4-week average flows are equivalent to USD 31.0bn

Balance sheet updates:

• the FED has now USD 6.4trn assets on the balance sheet - growing vs last week
• QE support to bond yields is strong on the current balance sheet size

IntroAs we already know from previous charts and comments, the FED plays an incredibly important role in stabilizing the European economies and markets. The FED’s main monetary policy tool to influence economic activity is through adjusting the short-term interest rate. But there are more tools available. The FED in fact may also want to affect long-term rates, something that can be carried out by buying or selling government securities and other financial instruments in open markets.

DefinitionsBuying or selling government securities (and eventually other financial instruments) in open markets is known as quantitative easing (QE) or tightening (QT), and is typically implemented when other monetary policy actions need to be reinforced. QT refers to monetary policy operations that contract or reduce the FED balance sheet (QT is also known as balance sheet normalization). QE refers instead to monetary policy operations that expand or increase the FED balance sheet (QE is also known as balance sheet expansion) .

How do QE/QT work in practiceUnder QT, the FED shrinks its monetary reserves by either selling European government bonds (spreading the sales country to country through specific ratios) or letting them mature and removing them from its cash balances. This removes liquidity from financial markets. Conversely, under QE, the FED increases its monetary reserves by buying European government bonds (spreading the purchases country to country through specific ratios) and adding them to its cash balances. This injects liquidity into financial markets.

In summary, QE/QT operations reinforce other monetary policy tools by affecting interest rates across the yield curve of government bonds (including long-term rates) and ultimately impact borrowing costs for companies and the government ultimately influencing economic activity - growth and employment.

Chart guideWe can see in the chart both the accumulated stock of assets in the FED balance sheet (shaded area) and the weekly new flows related to quantitative operations, either adding or removing assets from the FED balance sheet (and liquidity from markets).

Net bond supply in US after QE/QT

a look at the impact of FED demand on bond supply

how many bonds are available after FED operations?

Bond demand & supply dynamics in US:

• net bond supply remains positive but keeps trending down further
• the full bond issuance continues to remain available to private investors, as the FED is not demanding bonds: it runs quantitative tightening instead, withdrawing liquidity from markets

In summary and in light of the current FED quantitative operations, US bond yields are not currently supported by monetary policy given the positive net bond supply available

IntroIssuing bonds is one way for companies and governments to raise money. Total bond issuance is the cumulative amount of bonds issued by all companies and governments in a period in a certain region and available for investors to buy.

Back to basics: what is a bondA bond works like a loan between an investor and a corporation, or government. The investor agrees to give the bond issuer a certain amount of money for a specific period of time. In exchange, the investor receives periodic interest payments. When the bond reaches its maturity date, the bond issuer repays the investor.

FED and available bond supply in USDopeAs anticipated in the comments under the left chart, the FED can run open market operations to add or remove liquidity from market via bond purchases. If the FED runs quantitative easing, it acts as a major buyer of bonds on the market. Conversely, when it runs quantitative tightening it may either turn into a major seller of bonds held in its balance sheet or just not participate into new issuance.

Those quantitative operations affect net bond supply (i.e. the amount of bonds available to buy after issuance, net of FED purchases or sales) and can subsequently drive bond yields and bond prices.

Chart guideWe show three things in the chart above: (1) total monthly bond issuance (in grey) in USDope, (2) inverted FED flows (in turquoise) where negative bars represent FED purchases (QE) while positive bars represent FED withdrawals (QT), (3) the difference between bond issuance and FED flows is shown via the yellow line, representing the net debt available

Key market implicationsIf the yellow line is above zero, available bond supply is higher than FED current demand. This means that bond supply is left entirely to private investors: if they buy all issuance, bond yields are likely to compress on average; if not, they are likely to widen, same things equal. Conversely, if the yellow line is below zero, driven by price-insensitive FED demand, bond yields are likely to compress (price higher), same things equal.