by Calculated Risk on 8/10/2010 06:14:00 PM

People are struggling with a name for the Fed's action today. I've seen QE 1.5 and variations, but perhaps the best comes from Asha Bangalore at Northern Trust who called it Quantitative Neutrality (QN), see: Fed Moves from "QE" to "QN"

The Fed's goal (according to the technical note from the NY Fed) is to "maintain the face value of outright holdings of domestic securities" at approximately $2.054 trillion.

Click on graph for larger image in new window.

The red line on this graph is the amount of outright holdings on the Fed's balance sheet. The dashed line is the new target level. This is about $17 billion below the peak of a few weeks ago.

The outright holdings were expected to fall by about $200 billion by the end of 2011 (some have estimated as high as $400 billion), and that would represent tightening in the face of high unemployment and below target inflation.

The NY Fed will announce the size of the September purchases tomorrow and that will give an idea of how much the Fed expected the outright holdings to fall. The recent increase in refinance activity might have accelerated the process.

by Calculated Risk on 8/10/2010 02:47:00 PM

From the Open Market Trading Desk: Statement Regarding Reinvestment of Principal Payments on Agency Debt and Agency MBS

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. The most recent H.4.1 data release indicates that outright holdings of domestic securities in the System Open Market Account (SOMA) totaled $2.054 trillion as of August 4, 2010. The Desk will seek to maintain the face value of outright holdings of domestic securities in the SOMA at approximately this level. Due to differences in settlement dates for purchases and principal payments, it is anticipated that the actual level of domestic securities held will vary around this level to some degree.

In the middle of each month, the Desk will publish a tentative schedule of purchase operations expected to take place through the middle of the following month, as well as the anticipated total amount of purchases to be conducted over that period. The anticipated total amount of purchases will be calibrated to offset the amount of principal payments from agency debt and agency MBS expected to be received over that period. The announcement will occur shortly after the monthly releases of current MBS factors from Fannie Mae, Freddie Mac, and Ginnie Mae, allowing the Desk to anticipate the principal payments to be received by the SOMA portfolio over the period.

The first tentative schedule of purchase operations and the anticipated total amount of purchases to be conducted through the middle of September will be published tomorrow, August 11, at 3 p.m. The purchase schedule will include a list of operation dates, settlement dates, security types to be purchased (nominal coupons or TIPS), and a maturity date range of eligible issues for each scheduled operation. The Desk expects to begin purchasing Treasury securities under this policy on or around August 17.

The Desk will concentrate its purchases in the 2- to 10-year sector of the nominal Treasury curve, although purchases will occur across the nominal Treasury coupon and TIPS yield curves. The Desk will typically refrain from purchasing securities for which there is heightened demand or of which the SOMA already holds large concentrations.

Purchases will be conducted with the Federal Reserve’s primary dealers through a series of competitive auctions via the Desk’s FedTrade system. The exact list of securities eligible for purchase will be made available at the beginning of each purchase operation. The results of each operation will be published on the Federal Reserve Bank of New York’s website shortly after each purchase operation has concluded.

FAQs: Reinvestment of Principal Payments on Agency Debt and Agency Mortgage-Backed Securities in Treasuries

by Calculated Risk on 8/10/2010 02:15:00 PM

The key is the reinvestment of maturing MBS in long term Treasury securities!

From the Fed:

Information received since the Federal Open Market Committee met in June indicates that the pace of recovery in output and employment has slowed in recent months. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level. Bank lending has continued to contract. Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be more modest in the near term than had been anticipated.

Measures of underlying inflation have trended lower in recent quarters and, with substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

To help support the economic recovery in a context of price stability, the Committee will 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 in longer-term Treasury securities.1 The Committee will continue to roll over the Federal Reserve's holdings of Treasury securities as they mature.

The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh.

Voting against the policy was Thomas M. Hoenig, who judges that the economy is recovering modestly, as projected. Accordingly, he believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted and limits the Committee's ability to adjust policy when needed. In addition, given economic and financial conditions, Mr. Hoenig did not believe that keeping constant the size of the Federal Reserve's holdings of longer-term securities at their current level was required to support a return to the Committee's policy objectives.

The language about rates stayed the same: "The Committee ... continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period."

by Calculated Risk on 8/10/2010 12:41:00 PM

I think there are three things to look for in the statement today at 2:15 PM ET.

1) How will the statement discuss the recent economic slowdown?

From the June 23rd FOMC statement:

"Information received since the Federal Open Market Committee met in April suggests that the economic recovery is proceeding and that the labor market is improving gradually. ... [T]he Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be moderate for a time."

I expect the statement today to acknowledge the weaker data since the last meeting.

2) Will they express more concern about deflation?

Last month:

"[U]nderlying inflation has trended lower. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time."

Those sentences might remain the same.

3) And the BIG one: Will the FOMC change their reinvestment strategy?

Currently the FOMC is not reinvesting maturing MBS. This is passively shrinking the Fed's balance sheet, and probably at a faster rate than expected because of recent refinance activity.

The Fed might decide to reinvest the maturing MBS. If they do, the questions are: For how long (end of 2011)? And what will they buy (probably Treasury Securities, but what duration)?

My guess is there will be no change to the current MBS run off strategy.

by Calculated Risk on 8/10/2010 10:34:00 AM

This is an update on an old story ...

From Bloomberg: `Buy and Bail' Homeowners Get Past Loan Restrictions (ht Mike in Long Island, Paulo)

Real estate professionals call it “buy and bail,” acquiring a new house before the buyer’s credit rating is ruined by walking away from the old one ...

Freddie Mac and larger rival Fannie Mae cracked down on buy and bail in 2008 by banning in most cases the use of rental income from an existing home to qualify for a new mortgage unless the first property has at least 30 percent equity.

“There were a number of policies put in place to squelch this type of activity, but people who are savvy can always find a way to circumvent policies,” said [Meg Burns, senior associate director for congressional affairs and communications at the Federal Housing Finance Agency] ...

In addition to the rental restrictions, the mortgage giants now usually require reserves equal to six months of loan payments for both homes. The measures have been sufficient to block most applicants who attempt to buy and bail, said Pete Bakel, a spokesman for Washington-based Fannie Mae.

It is really only "buy and bail" if the home buyer intends to walk away from the original house. With these new restrictions, I doubt this is a significant problem any more.

by Calculated Risk on 8/10/2010 08:10:00 AM

From the National Federation of Independent Business (NFIB): Small Business Economic Trends

Click on graph for larger image in new window.

NFIB reported its optimism index fell 0.9 point to 88.1 in July. (Graph from NFIB)

Here are the details:

The Index of Small Business Optimism lost 0.9 points in July following a sharp decline in June. The persistence of Index readings below 90 is unprecedented in survey history. ...

Labor Market
Ten (10) percent (seasonally adjusted) reported unfilled job openings, up one point from June but historically very weak. Over the next three months, nine percent plan to increase employment (down one point), and 10 percent plan to reduce their workforce (up two points) ...

Capital Spending
The frequency of reported capital outlays over the past six months fell one point to 45 percent of all firms, one point above the 35 year record low reached most recently in December 2009. The percent of owners planning to make capital expenditures over the next few months fell one point to 18 percent, two points above the 35 year record low.

Credit
[C]redit availability does not appear to be the cause of slow growth as many allege. Four percent of the owners reported “finance” as their top business problem, down two points. Pre-1983, as many as 37 percent cited financing and interest rates as their top problem. What businesses need are customers, giving them a reason to hire and make capital expenditures and borrow to support those activities.

Note: A large percentage of small businesses are in real estate related fields and that will keep optimism down.

Once again the key problem is lack of demand.