Time to Pay the Piper
Wall Street Journal Letter to the Editor Submission
Regarding your article "Pushing and Pulling on Rates Riddle" of 3/20/2015, rates are a riddle because of a fundamental misunderstanding of fixed income markets by investors. That is, just because QE has been tapered down to zero does not mean that the Fed has ceased purchasing Treasuries in the open market.
20% of the Fed's $2.4 trillion in Treasury holdings matures every year and must be re-purchased by the Fed to achieve Janet's Yellen's unheralded commitment to keeping the Fed balance sheet unchanged. Until such Fed purchases have fallen to zero, the taper is not finished. However, siphoning $480 billion, or 3% of GDP, from the economy every year to pay the Fed back would reduce GDP growth to zero for the next five years--an intolerable political solution.
The country could probably only afford to reduce the Fed's balance sheet by $200 billion per year at most, causing years of sub-par economic growth, unless desperately needed fiscal reforms were introduced to boost growth. That implies 12 more years before the Fed should consider raising the federal funds rate assuming the Fed cuts re-purchases by $200 billion per year. Until then, reduced re-purchases in and of themselves would have more impact on fixed-income markets than any premature raising of the federal funds rate. Why is this not on the Fed's agenda?
The Fed's benevolence over the last four years has not come without a price. Until the Fed's balance sheet is reduced back to zero, the Fed itself, through its re-purchases, will be the biggest obstacle to achieving higher market rates through an increase in the federal funds rate.