Janet Yellen Is Just Going To Pour Herself A Glass Of Red, Sit Back And Unwind (A Few Trillion Dollars Of Fed Assets)

We could all use a drink or three.
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A lot has changed since the Fed first started pumping up its balance sheet back in 2008. The Cubs won the World Series. Lloyd Blankfein became woke. Bill Gross went to Janus.

yellen-wine

The Fed couldn’t have predicted any of these things. Neither could they have predicted that what began as a few hundred billion in asset purchases would balloon to $4 trillion over the next several years. Nor could they have imagined that, as they convened to plan to the long-awaited unwind of all those asset purchases, the president of the United States would stand in front of the U.N. General Assembly and explicitly threaten to wipe another country off the face of the earth. Also that the president would be Donald Trump.

Yet here we are:

The Federal Reserve on Wednesday likely will announce the beginning of a yearslong program to shrink its bond portfolio and could offer clues about the prospects for another rate increase this year. Officials will release a statement and their updated quarterly economic projections at 2 p.m. EDT, after the conclusion of their two-day policy meeting.

We came into this era innocent and naive. Never having lived through a period when the central bank buys a medium-sized country’s GDP worth of debt over the course of a lazy afternoon, we can be forgiven for predicting hyperinflation or whatever. Now that American QE is over and we’ve got nothing but this lousy stock market to show for it, we should approach the big unwind with at least a modicum of humility. Because really, who knows what the fuck.

Here’s a cautious Jamie Dimon earlier this summer:

“We’ve never have had QE like this before, we’ve never had unwinding like this before,” Dimon said at a conference in Paris Tuesday. “Obviously that should say something to you about the risk that might mean, because we’ve never lived with it before….it could be a little more disruptive than people think,” Dimon said. “We act like we know exactly how it’s going to happen and we don’t.”

For a little more hyperventilation, see Mr. Gundlach:

“You go into a cumulative ... quantitative tightening. So I‘m wondering if this suggests a little more trouble in 2018,” Gundlach said about the reversal of QE. “I am thinking that maybe we have to start going on ‘Trouble Watch’ for the middle part, perhaps, of 2018 with quantitative easing scheduled to go away.”

Both are correct in their own ways. We probably shouldn't be complacent here. The Fed’s balance sheet is like one of those massive spaceships in alien movies that hover ominously over major population centers, their capabilities and intentions unknown. We all kind of acknowledge that it could destroy us, but for now we’re just gonna sit tight and keep a close eye on things. You don’t want to be the guy who stands underneath the pulsing dome at the tip of the UFO and explains how they're probably benign and we’ll all be fine. He usually gets vaporized. Nor do you want to be the raving loon who preaches end times when all the aliens wanted was to share their one weird trick for avoiding extinction.

Still, it’s not like we know nothing going into the great unwind. For one thing, we know who not to listen to: “bond gurus.”

During each of the Fed’s quantitative-easing cycles, yields rose when the central bank was buying and then fell after it stopped. That ran counter to what many expected based on simple supply and demand as the Fed amassed $4.5 trillion of debt and became the single biggest holder of Treasuries.

We were all told that it would be wise to short Treasuries after each round of QE, since who would all the buyers be once the Fed stepped back? Turns out, they were all of us. 

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