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The fed will beginning to unwind its $4.5 trillion balance sheet before the end of the year. “The uncertainty surrounding this unprecedented decision will source a stiff headwind in the face of the economy which has yet to simmer,” Jeremy Klein, chief market strategist at FBN Securities, said in a note Monday, referring to the balance-sheet reduction.

In your opinion, will the unwinding cause “stiff headwinds,” and if so why?

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Posted by John M. Wilkins
Posted on 06/19/2017 2:23 PM
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Depends on how it’s done. If they undwind the portfolio quickly then it could shock the markets. I suspect they won’t do that. In that case they’re more likely to be a marginal price impact so I don’t see what the fuss is all about.

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Cullen Roche Posted by Cullen Roche
Answered on 06/20/2017 12:38 PM
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    Cullen,

    You have explained often (and well) how QE is simply an asset swap and does not ‘print money.’ That being the case, why does it matter if QE is unwound quickly or more slowly? Still trying to understand the big picture …

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    Posted by Jay Hattler
    Answered on 06/24/2017 10:34 AM
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      Hi Jay,

      With a balance sheet of this size they could cause a big market move. So, let’s say they just started dumping T-Bonds. What would happen? It could cause some short-term disruption. I don’t think they’ll do this. But if there’s a risk to unwinding then this is it…

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      Cullen Roche Posted by Cullen Roche
      Answered on 06/24/2017 2:54 PM
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        Hi Cullen,

        I’m confused dot com here again…

        Can you please clarify why the Fed needs to unwind its Balance sheet in the first place? I think you mentioned the Fed made a profit of $90bn or something and most of this is directly paid off to the Treasury. If the government bonds are being “paid off” to maturity by the Fed doesn’t that effectively destroy the government bond? So why would it increase the supply of bonds in the market if the Fed unwinds its balance sheet?

        Another thing – why is the Fed paying interest on bonds it acquired from Banks by creating reserves ex nihilo?

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        Posted by Incognito 7
        Answered on 07/06/2017 7:04 AM
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          They don’t have to unwind the balance sheet. But they want to “normalize” policy so they are.

          They pay reserves to set the overnight rate. If they didn’t do the size of the reserves would lead to downward pressure on rates. This puts a floor on rates by basically enticing banks not to lend reserves to other banks at a lower rate.

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          Cullen Roche Posted by Cullen Roche
          Answered on 07/06/2017 12:18 PM
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            Cullen “‘They don’t have to unwind the balance sheet. But they want to “normalize” policy so they are.” What is “normalize”? Some folks want to go back to the boom and bust so-called “business” cycle so they can make moolah from the ups and downs. The slow and steady GDP growth is not giving them the day to day “delta” day traders crave.

            The Fed should keep the balance sheet and use it for controlling the ups. Our current Uncle Sam wants the economy to grow by 3% or more per year. This is the exact ticket for a boom and crash ride that these folks love.

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            Posted by Dennis
            Answered on 07/08/2017 8:25 PM
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              yelln is testifying again. I still have no good idea why it is important to unwind the balance sheet. Why is it important to “normalize” policy? Why can’t they just keep the status quo?

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              Posted by John M. Wilkins
              Answered on 07/13/2017 10:11 AM
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                Perhaps the key point is that reducing the balance sheet puts income producing assets back into the non-government sector.

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                Posted by John M. Wilkins
                Answered on 07/13/2017 11:41 AM
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                  John,

                  I think you have to remember that they’re totally out of paradigm with my view. The Fed thinks that the balance sheet is stimulative. So, maintaining the large balance sheet is causing growth to be higher than it otherwise would be. By reducing it the Fed thinks they can normalize policy by getting the portfolio back to a less stimulative position. This is all consistent with their desire to raise rates and slow a potentially overheating economy.

                  I disagree with so much of that. I don’t think the economy is booming. I don’t think it’s in need of being constrained. And I don’t think QE or balance sheet reduction has anything to do with most of that. In fact, as you stated, unwinding the balance sheet might be stimulative because it adds to private sector incomes.

                  So, long story short is, if you read Pragcap, you are not in paradigm with the Fed’s views.

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                  Cullen Roche Posted by Cullen Roche
                  Answered on 07/13/2017 1:59 PM
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                    Thanks Cullen, that makes sense. One final question: Why do you think they believe the large balance sheet is stimulative. The only thing is does that I can see is create a Fed profit that it turns over to the Treasury. That, I guess reduces the deficit a little, but little else it seems. The only other thing I think of is that they think that having so many assets out of the market creates “stimulative” demand for stocks, bonds and other assets perhaps creating “irrational exuberance”???

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                    Posted by John M. Wilkins
                    Answered on 07/13/2017 6:44 PM
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                      At this point it’s mainly the “expectations channel”. The Fed has maintained the balance sheet which sets the expectation that the Fed is stimulating the economy. Academics like to think this is actually stimulating. It’s kinda funny. Like, I expect to run as fast as Usain Bolt when I go for a run today therefore I might stimulate my running to be that much more effective. Except, of course, the fundamental fact is that I am a slow unathletic white guy so I run more like Homer Simpson. I don’t totally discount the idea of animal spirits, but c’mon. When we know something isn’t stimulative then animal spirits don’t work. But these academics don’t always live in the real world…

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                      Cullen Roche Posted by Cullen Roche
                      Answered on 07/13/2017 6:49 PM
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                        “Expectations channel”? LOL!

                        The Fed having a large balance sheet is directly correlated (in a quant sense) to lower short term interest rates. So by unwinding it, it will raise short term rates as the “expectations channel” plays hot potato. I don’t think you can read too much into anything that comes out of Yellen’s piehole or the other Governors. They live in an alternative bubble reality that isn’t based upon facts. They’re just purveyors of false hope. People want that, apparently.

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                        Posted by MachineGhost
                        Answered on 07/14/2017 8:45 PM
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                          Actually, if the “velocity of money” doesn’t increase as the unwinding commences, I think another economic theory will be biting the dust.

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                          Posted by MachineGhost
                          Answered on 07/14/2017 8:47 PM
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                            Money velocity has nothing to do with any of this. Do you even read this website???

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                            Cullen Roche Posted by Cullen Roche
                            Answered on 07/14/2017 9:10 PM
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                              Of course I read your website, but I don’t take your opinions as gospel. Not everything you write is always about “operational reality”.

                              If unwinding the balance sheet doesn’t fluff up the “expectation channel” then you wouldn’t expect the “velocity of money” measurement to increase either. How is that even controversial?

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                              Posted by MachineGhost
                              Answered on 07/16/2017 2:51 AM
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                                MG, velocity of money is one of those operational realities though. Maybe you missed this:

                                http://www.pragcap.com/the-mvpy-myth/

                                Velocity is only useful if it’s constant. Friedman knew this, but then when the data didn’t mesh with his assertion then he was forced to admit that the whole concept was probably wrong. But the main point is that velocity doesn’t tell us anything that is necessarily useful.

                                These old monetarist concepts have been mostly debunked by now.

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                                Cullen Roche Posted by Cullen Roche
                                Answered on 07/16/2017 12:47 PM
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                                  I read this today: “We believe this is why the Fed has quickened its pace to start shrinking their balance sheet. Rather than being forced to overshoot interest rates, which could adversely affect the economy, the Fed will start draining reserves through balance sheet reduction hoping to introduce some risk aversion and sense back into the giddy global markets.”

                                  From this website: https://macromon.wordpress.com/2017/07/16/market-liquidity-conditions-still-loose-as-a-goose/

                                  Does this ring a bell with anyone?

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                                  Posted by John M. Wilkins
                                  Answered on 07/17/2017 6:34 AM
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                                    I wasn’t reading your blog in 2015 but that was very interesting. I guess my concept of the “velocity of money” isn’t that Equation of Exchange or even a narrow concept of central bank money, but a more general and broader demand for money which should increase when short term rates go up (as people will want to get rid of the older money stuck at lesser rates). That’s technically inflation but most aren’t used to viewing inflation as a separate act for money itself.

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                                    Posted by MachineGhost
                                    Answered on 07/17/2017 10:30 PM
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                                      Posted by John M. Wilkins
                                      Answered on 07/26/2017 10:51 AM
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                                        John,

                                        The author never explains why normalizing int rate policy in the fed funds market is so important. It reads to me as if the author thinks that banks used to set the Fed Funds Rate and that the Fed has mucked up the system by setting it with IOER. This is backwards as the Fed still set the overnight rate before IOER. They just did so in a much less precise way. So, if anything, returning to normal policy is the same thing with a slightly less efficient tool to achieve it. So, I don’t see how this matters that much….

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                                        Cullen Roche Posted by Cullen Roche
                                        Answered on 07/26/2017 8:14 PM
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