Tim Duy on the balance sheet run-off

Tim makes what seems to me to be a strong case against the idea that balance sheet run-off at the Fed will be a big deal for the economy.

His argument basically boils down to the claim that the Fed can coordinate its interest rate and balance sheet policies to avoid an excessive tightening.  An excessive tightening is alway a risk, but it is not the base case and the risk of it is not meaningfully increased by the balance sheet issue. Well argued, IMV.

If anything, I think Tim understates his case, by accepting the standard view that QE has a meaningful impact on bond yields. In discussing the 2013 tantrum, for example, he utterly overlooks that the whole experience actually had little to do with tapering per se. As I have mentioned a couple times, Bernanke has apparently-recently swung round to accepting this take. Bernanke saying it does not make it so, but I happen to agree, fwiw.

Tim cites Yellen’s claim that ending reinvestment might raise 10-year Treasury yields by 15 bps “during 2017”. *  Maybe, but that is an odd claim, as the standard story about how QE works suggests that it is the entire path of the expected forward stock that matters.  If that estimate of the yield impact incorporates the effect of all the discounting assumed in the standard story, then what are we really talking about here?

Sorry to be “conspiratorial” about it, but I would rather be right than appear “fair”. I don’t think it is helpful to assume that the Fed leadership even believes any of this stuff.  People lie, and the Fed leadership is fibbing in what it takes to be the national interest. So there is no need to gasp and clutch your pearls, guys. This is pretty small beer.  Your parents fibbed to you about Santa. And the Fed fibs to you about what it is doing. No biggie.

It seems to me that the Fed leadership was very keen to emphasize QE’s huge effects while it was coming and then to get more realistic when QE was going. Is that too harsh?  Crazy conspiracy theory? Or plain obvious?

Speaking of fibbing, I had not previously read Yellen’s speech of Jan. 19, to which Tim refers. Having done so, I would ask you to engage your disbelief and look at this with objective eyes.  Do you really think Yellen is offering a credible case that the Fed is being influenced in the least by the logic of a Taylor rule.  Yellen is trying to say that she is “guided” by the “good principles” in Taylor but is not slavishly following a rule. Well, how convenient, given what is afoot in Congress! In fact, Yellen is quite appropriately respecting the fact that Taylor is useless near the zero bound.

But watch how she squirms.  She claims that the appropriate level for the fed funds rate coming out of a Taylor-type rule depends on what estimate of the neutral rate you use. No shit, Janet!

For any fed funds rate target you might dream up for some other reason, there is some Taylor-like rule to justify it, including a “change rule.” But what is the point? Why not get Ocham in here?

If this nonsense were promoted by anybody without the power to ruin your quarter or your year or your career as an investment professional, then it would be quickly recognized as the utter nonsense that it is. People would just laugh and knowingly say “epicycle.” Ha ha ha.

In fact, though,  we are all really “affected”, in the 18th century sense of the term, by POWER. I am not criticizing the Fed. I am criticizing people who think it is some huge scandal to accept the simple point that they fib. No biggie.


Yeah, you can parallel shift it up and down as you like.


* This footnote is not to disagree with Tim, because he actually emphasizes that Yellen’s estimate implies no big deal — if correct.  But just to emphasize the sheer magnitude of the nonsense around QE analysis, we are meant to believe that announcing run-off, presumably to continue until the newly-appropriate balance sheet size is fully achieved, would be worth 15 bps on 10-year yields “during 2017.” And yet people also believe that the 100 bps back-up during the taper tantrum of 2013 was due to the fear of the Fed slowing the rate at which it might accumulate.  To me, the gullibility around this whole issue is a recurring source of amazement.