Tuesday, October 7, 2008

Some Observations on the Fed Balance Sheet

As I mentioned before, I have started to follow the Fed balance sheet a bit. One of the most striking observations is the drastic shift in the composition of assets, as the graph below shows:

As can be seen in the graph and Fed has significantly decreased the Treasuries in its balance sheet as it supports the financial system with ample credit. What I am wondering is how such an increase in supply in Tbills and bonds outstanding (in the market) would effect yields. For now, if anything there is too much demand rather than too much supply, as money market funds, among others, are increasing their holdings of Treasuries. Moreover, there is a plethora of reasons to believe that yields are likely to go up, not down- see here for a good argument. However, the effect of Fed's lifeline support is definitely a factor that needs to be kept in mind going forward.

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