From Precision Capital Management:
This morning, Treasury released the quarterly Minutes of the Meeting of the Treasury Borrowing Advisory Committee Of the Securities Industry and Financial Markets Association, which isHT: Wall Street Cheat Sheet[A]n advisory committee governed by federal statute that meets quarterly with the Treasury Department. The Borrowing Committee’s membership is comprised of senior representatives from investment funds and banks. The Borrowing Committee presents their observations to the Treasury Department on the overall strength of the U.S. economy as well as providing recommendations on a variety of technical debt management issues. The Securities Industry and Financial Markets Association does not participate in the deliberations of the Borrowing Committee.
Though the Committee had some interesting things to say about 30 Year TIPS and inflation expectations, we will focus on the statements of one member’s presentation regarding the Federal Reserve’s exit strategy (with respect to the >$1 trillion in excess reserves held by banks on its balance sheet). We are not told just who the presenter is, but the Committee members comprise the most highly influential firms on Wall Street, including representatives from JP Morgan (Chairman), Goldman Sachs (Vice Chairman), Soros Fund Management, and Pimco. From the minutes:
The Committee then turned to a presentation by one of its members on the likely form of the Federal Reserve’s exit strategy and the implications for the Treasury’s borrowing program resulting from that strategy.
The presenting member began by noting the importance of the exit strategy for financial markets and fiscal authorities. It was noted that the near-zero interest rates driven by current Federal Reserve policy was pushing many financial entities such as pension funds, insurance companies, and endowments further out on the yield curve into longer-dated, riskier asset classes to earn incremental yield. Treasury securities have benefitted from the resultant increase in demand, but riskier assets have benefitted even more. According to the member, the greater decline in the indices for investment grade and high-yield corporate debt relative to 10-year Treasuries and current coupon mortgages displays this reach for yield. A critical issue will be the impact on the riskier asset classes as market interest rates move away from zero. [This is a shot off the bow to HY and, especially, CRE—more on this in another post.]
Here’s where it gets interesting:
The presenting member then looked at the likely sequence of the Federal Reserve’s exit strategy. The member acknowledged that the central bank must address the uncertainty and fragility of the economic recovery and the dependence of the housing market on low rates. It was suggested that the most likely sequence would be the [1] draining of excess reserves from the banking system, [2] the cessation of the mortgage-backed securities purchase program, and [3] only then raising the Fed funds target rate.
Several members at this point asked why draining reserves before ending the MBS program made sense. The presenting member noted that the program was already set to expire, and other measures, such as a revival of the Supplementary Financing Program, could be utilized by the Federal Reserve at the same time.
The Fed’s $1.25 trillion Agency MBS buyback program is set to expire at the end of March, 2010, according to the last FOMC Announcement from September 23, 2009. The point of the “several members” is valid, because why would the Fed drain reserves, only to continue adding them as a result of MBS purchases? The presenting member points out that the Fed can avoid adding reserves after they are first drained through a revival of Treasury’s Supplementary Financing Program (SFP)....MORE
