Weekly Relative Value - QE to Infinity

Weekly Relative Value, by Tom Slefinger, Alloya Investment Services, takes a look the impact of world economics on your credit union's balance sheet. It is provided in partnership with Alloya Corporate Federal Credit Union. The views of the author do not necessarily reflect those of the Cooperative Credit Union Association.

By Tom Slefinger, Alloya Investment Services

“It may be that there is a simple macro fact that the Treasury market being so much larger than it was even a few years ago, much larger than it was a decade ago and now really much larger than it was even a few years ago, that the sheer volume there may have outpaced the ability of the private market infrastructure to support stress of any sort there…

Will there be some indefinite need for the Fed to provide — not as a way of supporting the issuance of Treasuries, but as a way of supporting a functioning market in Treasuries — to participate as a purchaser for some period of time? I haven’t concluded that that’s the case, the institution certainly hasn’t concluded that that’s the case, but I do think it’s an open question.”

– Randal Quarles, Federal Reserve Vice Chair for Supervision

Last week, Federal Reserve Vice Chair for Supervision Randal Quarles, made surprisingly candid comments when discussing the ballooning size of the U.S. Treasury market and the central bank’s role in it. In essence, he alluded to the fact that the Fed will likely be in the quantitative easing (QE) game forever.

First, the most notable phrase in the above quote was “indefinite need.” I have never heard a Fed official mouth these words. Effectively, Quarles acknowledged that he’s grappling with the question of whether the Fed has no choice but to buy bonds forever.

The implication of this, of course, is that there is so much Treasury debt and it is potentially destabilizing. As such, the Fed may need to “monetize” the debt in some form, whether by conducting large-scale asset purchases or re-purchase agreements.

Later in the day, Quarles tried to walkback his remarks, saying, “I wouldn’t want the comments that I made today about thinking about Treasury market structure to suggest that I think that there’s some need for some permanent backstop of the Treasury market in normal times.”

Sure thing. I’d be curious to know what “normal times” means to Quarles and other Fed officials. Currently, and frankly for almost a decade, the Fed has suppressed long-term borrowing rates as a complement to keeping the fed funds rate near zero to boost the economy. Would the Fed allow interest rates to rise to their market-driven equilibrium levels and squelch the nascent recovery? Doubtful. So, is “normal times” when the central bank is raising interest rates again?