The TRUTH about the fed pivot. It's NOT what you're being told.

I wanted to wait for some more data to come in before making this, but it suffices to say that rumors of the fed pivot on social media are greatly exaggerated.

Charts of the fed's balance sheet have been circulating that look something like this, and people have been proclaiming the return of QE and monetary inflation.

https://imgur.com/rJgQYvT

People are predicting that the fed has already pivoted and that the money supply is about to explode again like it did in 2020. Maaaaaybe, but maybe not! Or maybe even probably not.

There's a fundamental misunderstanding when it comes to the fed's balance sheet. The fed's balance sheet can grow in two different, and opposite, ways. One way is the fed conducting open market operations (e.g. QE), where it buys securities (e.g. mortgage back securities and treasury bonds) directly from the secondary market. The other way is the fed merely makes collateralized loans against securities held by banks. That's done with a "repurchase agreement" through the fed's "discount window."

The difference is this. If someone takes out a home equity line of credit, that's analogous to a repurchase agreement, aka "repo." But if the bank were to outright buy a house from someone, that's analogous to open market operations.

This is a chart of the fed's balance sheet, including only securities that they own outright:

https://imgur.com/m1BZ8gf

As you can see, the fed is STILL tightening its balance sheet. That is QT is still in full swing. And obviously this paints a very different picture than the assumption that we're living through a repeat of 2019.

These two types of fed intervention have vastly different implications. Open market operations where the fed buys treasuries outright creates increased demand for government bonds, which can hypothetically bring rates down and expand the money supply. For example, if the primary dealers are selling bonds for a profit on the secondary market, and the fed is paying market prices, then that will almost certainly increase demand. Not only are the banks incentivized to buy more treasuries, the resulting drop in rates will incentivize the government to spend more. This is due to the fact that falling rates increase the value of bonds, meaning the fed will turn a profit on those bonds, which must be remitted back to the treasury. Effectively meaning that the taxpayers are able to borrow money at negative interest rates. Not only is the treasury not paying interest, they're actually getting more money back from the fed than they paid out. That's been the bond market for last 15 years. As long as interest rates are moving down, the money supply can increase for as long as there's demand for credit.

Repo, on the other hand, means that the banks are losing money on the bonds. Repo is something banks only use when they're hard up for cash. And that cash comes at a cost. They call it the "discount" window because the interest rates are higher than market, resulting in a so-called discount for the fed. It's set up that way to provide liquidity to banks that desperately need it, but at the same time to incentivise them to use the overnight market whenever possible.

So this is a very different dynamic. Rates are increasing, making the bonds worth less, and also shrinking the money supply, and deposits. Money can shrink in the same way it's created, just in reverse. That is, loans expand the money supply, but the money supply contracts when those loans are paid off, unless new loans are created at the same rate the old loans are rolling off. That forces the banks to sell treasuries to cover the withdrawals, and if there are unrealized losses due to rate increases then it can destroy them, just as it did SVB.

Now the aforementioned data I said I wanted to wait for before commenting is reserve deposits:

https://imgur.com/3BDrGSd

That's the money held by banks at the federal reserve. It's analogous to your checking account, but for a bank. Banks have checking accounts at the fed, basically, where they store their reserves.

In the last week or so, the fed's balance sheet has increased about 350 billion due to their overnight lending. The bank reserves have only increased about 250 billion. So the money is going out of the reserve accounts almost as fast as it's going in. In other words, the banks aren't being bailed out. They're leveraging assets to meet depositor demands, and in the long run will be worse off for it. They're losing the interest payments on the bonds, plus having to pay 4.75% interest to the fed. So effectively they're having to pay 8-10% interest to the fed in order to borrow this money to cover customer deposits. And of course the fed is insolvent still, so that money simply vanishes into a black hole, further shrinking the money supply.

So inconclusion, this isn't QE, it's the opposite of QE, and QE is probably functionally impossible right now. While there's nothing legally preventing the fed from buying bonds on the open market if they wanted to, the implications would be deflationary in the short term. QE is always deflationary in the long term (we're dealing right now with the long term consequences of QE done 15 years ago), but QE in this environment would probably be almost immediately deflationary. Because while it would initially stimulate borrowing, it would immediately start pulling more money from the circulating money supply in the form of taxes, and throwing it into the fed's giant black hole of insolvency. That is, the treasury would borrow say 100 dollars for a 1 month bill, and then have to immediately give back the 100 plus five bucks interest, which would vanish from the money supply. So the faster new money is created the faster the circulating money supply shrinks under those circumstances.

I hope this also gives you some insight into the debt ceiling crisis. This is the part the media isn't telling you. The government has gotten used to borrowing money at effectively negative interest rates over the last 15 years, and now they're having to actually service their debt. That means not only are they having to use taxes to replace the remittances from the fed they're used to getting, they're having to use tax revenues to pay the interest. So the cost to borrow money for the taxpayer has gone up tremendously in the past few months. And that's a massive problem for the government seeing as how tax revenues are going down in real terms. I.e. everything the government spends money on in the course of its operations has increased in price, but tax revenues aren't keeping up with the increased cost. E.g. increased medical cost for Medicare, increased cost of living for those on social security, higher government worker salaries, etc.

Yes, the government could increase taxes, but not without dire consequences that would be effectively killing the golden goose as it were. They would merely be increasing the rate at which the money supply is shrinking, AND accelerating the damage to the economy, creating job loss and lost economic opportunity, which would just result in even less tax revenue than they would have had, had they not raised the taxes. Ergo, raising taxes to fund a higher deficit would have almost immediate devastating consequences.

So yes I know the debt ceiling is a political football that's gotten kicked around a lot lately, but things really are different now, and the situation really is dire. If rates don't come down the the money supply doesn't begin expanding soon, I think there's a very real chance the government could actually default.