Bank of Japan and Bank of England Claim They Can Counter Fed Tapering (Kuroda-Bean at Jackson Hole)

Confounded Interest ^ | 08/25/2013 | Anthony B. Sanders

[whitedog57]

There are more rumblings from the Jackson Hole central banker party going on in Wyoming.

Central bankers from Japan and the U.K. predicted their new campaigns to encourage expansion will work, sustaining support for global growth even as the Federal Reserve considers a reduction in stimulus.

As the annual gathering of central bankers and economists in Jackson Hole, Wyoming, drew to a close yesterday, Bank of Japan Governor Haruhiko Kuroda said his souped-up asset-buying “has started to exert effects” on the world’s third-largest economy.

Bank of England Deputy Governor Charlie Bean said the U.K.’s pledge this month to avoid raising interest rates before unemployment falls to 7 percent should restrain U.K. gilt yields and boost confidence among consumers and companies.

So, The Bank of Japan and the Bank of England think that they can contain US Treasury and mortgage rates through their policies.

Here is the problem for the US. The Fed’s policy calls for keeping the interest rate at zero until the unemployment rate gets down to 6.5%.

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But by that time the best guess of the Fed’s reaction function would call for a rate above zero. [The following Taylor Rule chart is a simplistic estimate to make the point of what might happen if the unemployment rate hits 6.5%. Suppose that the unemployment falls to 6.5% and core inflation is 20% by July 2014. The Fed Funds Target would be 2.13%, not zero as it is today. [Again, this is a very simplistic estimate].

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Here is another problem. The Fed is the biggest buyer of duration and convexity risk in the world. According to Bank of America, The Fed is long the option to taper asset purchases (and eventually raise rates) if the data improves. That leaves the market short the option that the Fed may decide to taper. The market has looked to hedge this “short gamma” exposure by selling duration and buying vol.”

According to The Federal Reserve Board’s H.4.1 release on Thursday, August 22, 2013, the Fed’s balance sheet contains over $2 trillion in Treasuries spread over 1 to 30 years. They also hold over $1.3 trillion in agency MBS, the vast majority of 10 years.

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Duration risk? The 10 year modified duration is 8.75 and The Fed holds quite a few of these high duration Treasuries.

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Agency MBS durations are lower than 10 year Treasury durations, of course.

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But the concern for agency MBS is that rising mortgage rates reduce prepayments, thus extending the risk of agency MBS. Take the Fannie Mae 4% MBS, for example.

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Let’s see if Kuroda-Bean are correct. That would be welcome news for the mortgage and housing markets.

Frankly, the prediction that the Bank of Japan and Bank of England can offset a withdrawal by The Fed sounds like something I would expect Mr. Bean to say.

mr_bean-004

[whitedog57]

Mr Bean is right! ALL the central (statist) bankers are Mr. Bean.

[ChildOfThe60s]

According to The Federal Reserve Board’s H.4.1 release on Thursday, August 22, 2013, the Fed’s balance sheet contains over $2 trillion in Treasuries spread over 1 to 30 years. They also hold over $1.3 trillion in agency MBS, the vast majority of 10 years.

As a simple minded member of the "great unwashed" my thought is, what could possibly go wrong based on these numbers?

Does anyone know how the durations of this $2 trillion in Treasuries actually break down over this 1-30 year period? Seems like that could make a big difference.