The Bond, Gold & MBS Markets Will Be Taking Control of the Steering Wheel for a While…
An update of the Federal Reserve balance sheet charts for 1/7/11. As the calendar ticks through July, we’ll find that the balance sheet of the Federal Reserve will remain roughly as can be seen below. Resultantly, the course of monetary policy will be subject to the hopes and fears of the bond, MBS & gold markets for a while…
[The first chart shows the Federal Reserve's assets as recorded on the 'factors affecting reserve balances' statistical release. The second chart shows those assets on a proportional basis. That is, the latter chart shows the Fed's various assets as a percentage of its total assets.]
Now that QE2 has come to a close, we’ll find that the above charts will remain roughly the same over the coming weeks and months. The total size of the Federal Reserve’s balance sheet has reached around $2.9 trillion, and the Fed’s proportional holding of US Government notes & bonds is now in excess of 50% (compared with around 30% pre-QE2).
Over the past few months, we have maintained the contention that ‘QE2′ was probably an attempt to ‘clean up’ the balance sheet of the Federal Reserve (in spite of the widespread conviction that it was an attempt at uber-loose monetary policy). Most likely, officials at the Federal Reserve were alarmed by their own recklessness. For they had made dollars, which are the monetary reserve assets of the world, ‘good for’ Mortgage-backed securities. That’s really quite startling, given that the Federal Reserve has essentially stuck to gold, govt. bonds and — occasionally — Federal Agency debt securities since its founding in 1913! Moreover, this was corroborated by the fact that several other ‘clean-up’ measures were in progress over the QE2 period. Given that the same overly levered institutions dominate western economies today, we have also maintained that QE2 would ultimately ‘tighten the noose’. [Our view remains the same, although — as mentioned in the June newsletter — we have been anticipating a short-term rebound (which seems to be in progress).]
Thoughts on Gold:
Jim Grant often says (paraphrasing), ‘gold is the inverse of the world’s faith in the likes of Ben Bernanke & Co’. As gold remains the only hard asset on the world’s central bank balance sheets, we’re inclined to agree.
As mentioned here, we continue to believe that gold is in a long-term bull market, however, looking at the dynamics in the ‘discount from par‘, we have to be wary of the correction in gold for the coming weeks. Once we begin to see the dynamics becoming stretched, there may arise a good opportunity to add to one’s gold holdings:
Recommended: Charting the Federal Reserve's Assets - 1915 to 2012