Fed’s Quiet Balance Sheet Expansion: Buying Treasury Bills Amid Apparent Contraction

Original sourceQuoth the Raven, by Peter Schiff, SchiffGold

Compiled by Odaily Planet Daily, Qin Xiaofeng (@QinXiaofeng 888 )

This analysis provides a detailed breakdown of the Federal Reserve's balance sheet, covering its various components and changes in their amounts, along with historical interest rate trends.

Since February this year, the Federal Reserve has been quietly conducting quantitative easing. The pace of asset accumulation has slowed in recent months, with negative growth even recorded in August. When this round of quantitative easing was restarted, its goal was to purchase Treasury securities to maintain high liquidity. As shown below, this operation is still ongoing—the Federal Reserve net increased its holdings of Treasury securities by $29 billion in August. The net decline in the balance sheet is primarily due to the maturity and reduction of mortgage-backed securities (MBS) and 5- to 10-year Treasuries.

Figure 1: Monthly changes by tool

Extending the timeline to ten years and aggregating the data annually yields the chart below. Note that when the next crisis arrives, the Federal Reserve will swiftly “erase” all the “hard-won” efforts of its previous balance sheet reduction. It took four years to reduce the balance sheet by approximately $2.2 trillion, yet in 2020, it expanded by $3 trillion in just months, and by $4.5 trillion over two years.

This year to date, the Federal Reserve has expanded its balance sheet by $90 billion. While the increase is modest compared to recent years, it is noteworthy— the balance sheet is growing rather than contracting, making it harder for inflation to decline.

Figure 2: Monthly changes by tool

The table below provides a more detailed breakdown of the Fed's operations and recent efforts to manage its balance sheet.

The most noteworthy point is that over the past year, the Federal Reserve increased its holdings of Treasury securities by $344 billion! This increase is significant. Why is the Federal Reserve focused on purchasing Treasury securities? Treasury securities are typically the most liquid instruments in government debt issuance, so the Fed’s intervention for liquidity reasons is puzzling.

Figure 3: Balance Sheet Breakdown

Weekly operational details are shown in the chart below. The chart clearly shows the trajectory of weekly Treasury bill purchases.

Figure 4: Weekly Changes in the Federal Reserve's Balance Sheet

The chart below shows the balances of the loan and repo facilities. These were emergency tools established after the collapse of Silicon Valley Bank (SVB). All related facility balances have now been reduced to zero, but as mentioned above, the Fed seeks to see greater use of the repo market (the standard repo tool, i.e., SRF).

Figure 5: Loan Details

Since September 2022, yields across maturities have generally fluctuated within a range of approximately 3.25% to 4.75%. This range was broken in June—30-year yields decisively surpassed 5%, and 10-year yields exceeded 4.5%. This is precisely why the Treasury intervened in the market; they recognized fractures in the bond market that could have significant consequences.

Figure 6: Interest rate trends by maturity

The yield curve spread is widening again, indicating that investors are demanding greater compensation for locking up dollar funds for longer periods.

Figure 7: Yield Curve Inversion Tracker

The chart below shows the current yield curve, as well as the curves from one month ago and one year ago. The steepening of the yield curve is once again clearly visible, making the Treasury's operations more challenging.

Figure 8: Yield Curve Inversion Tracker

Perhaps most concerning is the declining international interest in U.S. Treasury bonds. The total amount of U.S. debt held overseas has fallen from its first-quarter peak of $9.4 trillion. As the U.S. Treasury issues more debt, the fact that foreign holders are not stepping in to buy is undoubtedly a very bad sign.

Note: Data is updated with a delay; the latest data is as of June.

Figure 9: International Holders

The chart below shows the holdings of major countries. China's holdings of U.S. Treasuries have declined to $630 billion, a reduction of $100 billion from last year. The United Kingdom currently holds more U.S. Treasuries than China. Japan's holdings have remained relatively stable over the past decade, fluctuating between $1 trillion and $1.25 trillion. Japan cannot become a seller, as doing so would intensify its pain. This is one of the reasons the U.S. intervenes in the foreign exchange market.

Figure 10: Weekly Average Changes in the Balance Sheet

The last chart examines the balance sheet from a broader perspective, clearly showing that since the global financial crisis, the Federal Reserve’s approach to managing its balance sheet has fundamentally changed. The chart also highlights the contrast between rapid expansion and slow contraction. In reality, the Federal Reserve can never shrink its balance sheet back to previous levels—it can only make minor reductions between crises, only to inflate it again during the next one. Based on the trajectory of the Federal Reserve’s balance sheet, the next crisis may be closer than anyone imagines!

Figure 11: Historical trend of the Federal Reserve's balance sheet

After Warsh took office, he introduced a new slogan: After more than five years of effort, the Federal Reserve is ready to control inflation. Easy to say, hard to do. This is really more of a mathematical problem. If the Federal Reserve raises interest rates, the cost of government borrowing will continue to rise—and that is unacceptable. The only option is to keep rates steady or cut them—they just need a suitable excuse.

Last Friday, on the podium at Jackson Hole, Federal Reserve Chairman Kevin Warsh clearly defined the red line for central bank credibility, declaring the Fed’s long-standing 2% inflation target for the Personal Consumption Expenditures (PCE) price index a “firm, fixed goal.” He stated that price stability “will not happen automatically… it is the Federal Reserve’s responsibility to achieve price stability, with no excuses.” Investors noted that gold reached a daily high of $4,612 per ounce on Thursday, reminding the market that investors remain wary of the possibility that inflation could persist well above the Fed’s comfort zone.

PCE inflation is running at 3.7% year-over-year, with a six-month annualized pace exceeding 4%. Even after cooling from post-pandemic peaks, 54% of items in the PCE basket have risen more than 3% over the past year, compared to just 32% before the pandemic. Waugh stated that the “65-month stretch of persistently high inflation” is entirely the responsibility of central banks. Comparable Consumer Price Index (CPI) data shows similar persistent pressure, indicating that price growth has not substantially improved.

Wash stated that the labor market is "largely consistent with full employment." Business investment in equipment and intangible assets grew at a rate of 9%, with over half related to artificial intelligence projects. Profit growth among S&P 500 companies exceeded 20%, with margins "quite high." Corporate bond spreads and leveraged loan spreads are trading near historical lows, and the July Senior Loan Officer Survey indicated a loosening of lending standards for business and industrial loans.

Wash also discussed the Fed’s own communication practices. He warned that conventional forward guidance could trap policymakers and market participants in a “hall of mirrors”—where both sides react to each other’s signals rather than to the real economy. He argued that short-term interest rates should remain the primary tool of monetary policy, adding that balance sheet experiments and other unconventional measures “should be used sparingly, if at all, under other circumstances.” Referring to monetary traditions before quantitative easing, he stated that “money matters,” and urged the Fed to focus on the money created by the central bank and the broader financial system.

Wash also views artificial intelligence as a "new variable" that could impact productivity, noting that the annualized token sales of two leading AI labs have exceeded $100 billion, more than tripling from a year ago. Faster productivity growth can help suppress prices over the long term, but the pace of AI-related investment has raised concerns about overheating, a trend also evident in recent gold price increases.

It remains to be seen whether the Federal Reserve can tame prices without launching another round of unconventional policies. For now, investors appear to be hedging against this uncertainty by continuing to hold and buy gold—a asset that has withstood inflation and recessions for decades.