Quantitative easing exit?

The Fed's QE Exit Will More Than Quadruple Interest Costs For The US

Zero Hedge,

1 May, 2013

With the Fed now openly warning that there may actually come a time when the 'flow' stops; the most recent Treasury Borrowing Advisory Committee (TBAC) report has some concerning statistics for those change-ridden hopers who see a smooth Fed exit, deficit-reduction, and blue skies ahead.  While they are careful not shout 'sell' in a crowded bond market; hidden deep in the 126 page presentation are two charts that bear significant attention. The first shows what TBAC expects (given the market's expectations) to happen to interest rates in the US as the Fed 'exits' its QE program (taper, unwind, hold) - the result, the weighted-average cost of financing for the US government will almost triple from around 1.6% to around 4.3% over the next ten years. But more problematic is that even with CBO's rather conservative estimates of the growth in US debt over the next decade the USD cost of financing will explode from around $205bn (based on TBAC data) to over $855bn. Still convinced the Fed can exit smoothly?

As TBAC warns:

Treasury yields could reprice notably when the market is convinced that policy tightening is imminent

There is a risk that markets may overshoot to higher-than-fair yield levels due to:

• Concerns about Fed portfolio unwind
• Inadequate interest hedging in certain asset classes
• Portfolio rebalancing by retail investors

Annual interest cost on public debt to increase more than 400% (from $205 bn in 2013 to $855 bn in 2023)

• Main driver : Increase in WAC from 1.7% to 4.3%
• Secondary factor : ~ 65% increase in stock of debt

Given the market's expectations for Fed tapering (or gradual tightening)...

The marginal cost of financing will rise significantly...

but with the sheer size of debt now (and growing), that will balloon the absolute cost of servicing US debt to over $850bn per year...

And just what happens to all those retirees - who need yield - who are being herded into stocks when Treasuries pay over 4.5%? Would seem bullish for bond flows... think Japan...

Charts: TBAC

Former Fed Governor Warsh Admits "There Is No Plan B"

Zero Hedge,

1 May, 2013

At the very crux of the financial crisis, former Fed governor Kevin Warsh notes, "experimental extreme monetary policy," had the "right risk-reward", but, he warns, in this excellent (and somewhat chilling) discussion at the Milken Institute, "we left a financial crisis more than for years ago." While the politicians may 'prefer' to think of this as a crisis - and indeed "for them it is a crisis as they preside over an economy that refuses to grow," which has tended to lead to loss of office, but, Warsh condemns, "they have run out of excuses." Over the last several years, "[the Fed] has over-promised and under-delivered," and the bank's most important asset - credibility - is under attack.

The Fed has "enabled" Washington to do nothing, since the politicians expect the same "rabbit out of the hat" rescue that occurred in the darkest days of the financial crisis. This means no growth strategies ("the mix of policies has to be right") will occur. Since the financial crisis, Washington has done its level best to focus on GDP in the next quarter, or perhaps the election, and precious little beyond that short-term horizon. Warsh concludes, "There Is No Plan B."

The Fed has fewer degrees of freedom and the rest of Washington is not coming to the rescue; and furthermore "the ability of a central bank, exclusively, without the rest of Washington doing any bit of the task, to turn an economy from a modest recovery to a robust one is an experiment that is untested - and will not prove to be successful

The entire discussion is worthy of attention but Warsh's comments begin around 18:00:

...but "the ability of a central bank, exclusively, without the rest of Washington doing any bit of the task, to turn an economy from a modest recovery to a robust one is an experiment that is untested - and will not prove to be successful."

...The Fed is taking on the problem of the shortfall in aggregate demand alone. Warsh does not believe that the Fed means to do this alone but their "good intentions" are simply not enough to get the economy to a 3-4% growth rate needed to create sustainable improvements in the labor markets.

... Warsh adds, "over the last several years, [the Fed] has over-promised and under-delivered," and the bank's most important asset - credibility - is under attack.

...The Fed has "enabled" Washington to do nothing, since the politicians expect the same "rabbit out of the hat" rescue that occurred in the darkest days of the financial crisis. This means no growth strategies ("the mix of policies has to be right") will occur - until the Fed draws the line.

...Since the financial crisis, Washington has done its level best to focus on GDP in the next quarter, or perhaps the election, and precious little beyond that short-term horizon. Warsh concludes, "There Is No Plan B." The Fed has fewer degrees of freedom and the rest of Washington is not coming to the rescue.

...In light of our status as reserve currency, the rest of the world's central banks feel empowered to match the Fed's efforts since "we do not act in a vaccuum" which due to economic and comptetive reasons, means "the US economy will not break out to the upside."

...It is not bad luck that is creating this medicority, it is bad policy

Then at 36:30, Warsh expands on the Fed's awful alternatives and his views on whether Bernanke's transmission channels via Animal Spirits and portfolio rebalancing will have any lasting impact...