The balance sheet unwind for the Federal Reserve is proceeding at a snails pace. After a rather large jump in the securities holdings last week, we should have seen a resumption in the balance sheet shrinkage. Interestingly the Fed’s holdings of Treasury and mortgage securities only fell by $4.8 billion this past week. A look at the weekly System Open Market Account Holdings shows there is a lot of work to do in the last week of the year if the Fed is going to stick to it’s stated unwind schedule.

While the Fed has managed to roll off close to $20 billion in Treasury securities, their portfolio of mortgage backed securities has actually increased since the beginning of October. The Fed’s Dec 2o MBS holdings were about $7 billion higher than the balance of securities held on October of this year.

When the Federal Reserve announced in September that they would commence with the balance sheet unwind beginning in October many people, myself included, were skeptical of how the Fed was going to extricate itself from its position as the primary dope dealer for Wall Street and asset markets in general. That’s the problem with a junkie. Once you establish the addiction, the patient needs more and more of the stimulus to maintain the “high”. This explains why the Fed balance sheet draw-down is well off of their projected estimates heading into the last week of the year. Barring a miraculous surprise in the last weak of 2017, the Federal Reserve will not meet it’s target of $30 billion in reductions for the fourth quarter of the year.

As a reminder, the Federal Reserve said it would start in October with decreases of $6 billion per month in Treasury securities and $4 billion per month in mortgage securities. The unwind schedule was telegraphed at the June FOMC meeting, noting that the unwind would progress with the amounts increasing at 3-month intervals until the total monthly unwind hit a combined $50 billion ($30 billion decrease in Treasury securities and a $20 billion decrease in in mortgage securities).

  • For payments of principal that the Federal Reserve receives from maturing Treasury securities, the Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month.
  • For payments of principal that the Federal Reserve receives from its holdings of agency debt and mortgage-backed securities, the Committee anticipates that the cap will be $4 billion per month initially and will increase in steps of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month.

As we head into 2018, all eyes will be on the Federal Reserve to see if they put their proverbial money where their mouth is. If the Fed balance sheet shrinkage does progress with bigger draw-downs every three months, things are going to get interesting. The reasons for this are so obvious even a Layman could understand it. Amazingly Fed officials think they can avoid the consequences of tinkering with markets, artificially suppressing interest rates, volatility and market cycles across in general. The fact that they haven’t even reduced their MBS portfolio in the fourth quarter suggests Fed officials are getting some cold feet. What could they be afraid of?

There is a lot riding on the Fed’s policy actions. Both the stock market and housing market could be affected if things don’t go according to plan. It’s easy to see how the Fed’s balance sheet unwind could be the single biggest story for the housing market in 2018. A look at the Fed’s historical record on forecasted economic growth suggests we could all be in for a bumpy ride.