Which of These Comes First – More Treasury Hoarding or a Rate Hike?

In the investment banking universe, there’s no more contentious issue than Federal Reserve policy.  This week’s interest rate decision will be no different.

On Wednesday, the Federal Reserve is set to announce its decision on the Federal Funds target rate.  Unless the Fed shocks the world, and with Janet Yellen at the helm that’s a very unlikely scenario, the Fed will keep the target rate where it’s been for the past over 8 years.  The rate is currently set at between 0% and 0.25%.

The incredibly loose Fed presents an interesting question.  Which of the following two will jump up first?  Will the Fed increase its holdings of Treasuries or will it raise the Fed Funds target rate?

First, a Look at the Treasury Holdings

The following graphic is a look at Treasury holdings of the Federal Reserve from 2003 to 2015’s most recent figure.  Over this period, there have been 3 jumps in Treasury holdings and 1 drop.

Addressing the drop first.  From November 2007 to June 2008, the Federal Reserve’s holdings of Treasury securities declined by about $300 billion to ~$480 billion.  The drop stemmed from the onset of the global financial crisis, with the Fed selling assets to individuals looking for safe harbor securities.

Next, the 3 jumps – which all occurred for generally the same reasons.

The first jump occurred from March to September 2009, with the Fed’s holdings expanding by almost the $300 billion it sold the prior year.  The purchases occurred as an attempt to lower long-term borrowing costs and encourage economic activity.

The second jump began in August 2010 and lasted to October 2011.  Over this period, the Fed’s holdings exploded by almost $1 trillion, to $1.7 trillion.

The third jump lasted the longest, from December 2012 to October 2014, with the Fed purchasing another about $800 billion in Treasury securities.

Overall, the most recent accounting has total Federal Reserve Treasury holdings at $2.464 trillion, about $1.7 trillion above where it was prior to the global financial crisis.

Treasury Holdings of the Federal Reserve

Second, a Look at the Fed Funds Target Rate

The following graphic is a look at the Federal Reserve loosening cycles since the 1970s.  A loosening cycle begins when the Fed starts lowering interest rates, and ends when the Federal Reserve starts raising interest rates.

As indicated, the current cycle isn’t exactly a short one.  To the contrary, the current loosening cycle is about 3,000 days long, much longer than the previous longest loosening cycle that began in 1989 and ended in 1994.  This cycle lasted about 1,700 days.

Loosening Cycles by Start Year

So, Which Comes First?

The question regarding which comes first depends partly on the state of the American and global economies and partly on the personalities in charge of Federal Reserve policy.  Given that global economic conditions are generally weak, and the sitting chairwoman of the Federal Reserve has a large bias towards loose monetary policy, it’s a reasonable bet that the Fed starts buying Treasury securities before it begins addressing much needed normalized Federal Reserve interest rate policy.


The Federal Reserve is set to announce an interest rate decision on Wednesday.  Unless the financial world is caught completely off guard, it is likely that the Fed will leave the Federal Funds target rate exactly where it is, and where is has been for 8 years.

The incredibly loose Fed raises an interesting question, especially in light of chairwoman Janet Yellen’s bias for loose monetary policy.  Which will happen first – Will the Fed enter another round of Treasury hoardings, or will the Fed begin to raise interest rates?

Although the baseline presumption among economists is that a rate hike is pending, there’s a good deal of reason to believe that more money printing to buy Treasury securities will be the next step of the Federal Reserve.

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