Why the Fed Will Have to Start QE Again | by Armchair Banker | October 2023

Courtesy: James Lavish, CFA Twitter

The 10-year Treasury rate is reaching its maximum. For the first time since 2007, the US Treasury yield reached 5+%. Things aren’t looking good for Washington.

It couldn’t have come at a worse time for the American economy. Inflation is already on the rise due to supply chain disruptions and geopolitical uncertainties throughout 2022. The Federal Reserve (Fed) has found itself in a position to act. The years of maintaining near-zero interest rates and massive money printing had to end (what investor Howard Marks calls a “sea change”).. As a result, the Fed has implemented a rapid series of interest rate hikes, resulting in the current Fed funds rate of 5.5%.

Can Washington effectively fight inflation? As I discussed earlier, The US economy is heavily financialized, with debt playing a significant role in its growth. Recent rate hikes have resulted in Washington’s interest payments on its debt exceeding its defense spending. Additionally, over the past decade, the US economy has become more indebted due to an extended period of low interest rates. This environment supported a an inflated asset bubble built highly leveraged due to extremely low cost of capital. Now that interest rates are rising, the Federal Reserve finds itself dismantling what it originally created.

Another challenge facing the US Treasury is the shrinking macroeconomic incentive to hold what is traditionally considered “risk-free” US debt. As I discussed earlier, collapse of SVB resulted from significant losses in the securities portfolio. Unlike the financial crisis in 2008, when banks invested massively in securities backed by risky mortgages, the fall of SVB was linked to the holding of US government bonds. The sharp increase in rates led to a decrease in the value of the banks held, which ultimately contributed to its demise.

Courtesy: Paranoid Bull

This is not limited to regional banks such as SVB. Even Bank of America faces a significant challenge, with unrealized losses on its fixed-income holdings totaling a staggering $131.6 billion. It is important to note that these losses are not associated with comprehensive…

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