Sullivan's Market $ense

Brian B. Sullivan, CFA, President and Chief Investment Officer, Regions Investment Management

January 20, 2015

A column to help investors gain perspective on today's market noise

Yellen as Portfolio Manager

Over the last several years the Federal Reserve has built a very large portfolio.  $4,559,960,000,000 as of mid-January.  As portfolio managers our minds turn to what does that portfolio look like?  The two biggest portions are US Treasury notes and bonds of $2.3 trillion and mortgages of $1.7 trillion.  These are readily marketable securities which have been bought in the market since 2008. 

John Boston, our head of fixed income, proposed a pretty radical idea.  What if the Federal Reserve sold its excess holdings? Not over time but now.  I estimate that of the $4.5 trillion in the portfolio at least $3 trillion is excess.  After all, in 2007 the portfolio was less than $1 trillion.  So what would selling $3 trillion treasury and mortgage securities do?

In this environment of large demand for US Government securities it would not likely bring yields up to more than they were a year ago.  Ten year Treasury securities trade at a yield of about 1.80% now versus 3.04% at the end of 2013.  I suspect a big sales program would raise rates but not to 3%.  It might knock out some of the Irrational Exuberance that currently exists in world debt markets. 

A large scale sale would help satisfy foreign and domestic demand for these bonds.  Giving investors ample securities to buy may stem the apparent frenzy for US assets.  It might help the Swiss too.

Calming foreign investor fears of insufficient US investments will also help slow the strong rally in the dollar.  The strong dollar makes us less competitive in world markets.

A large scale sale also relieves investors concerns about the bloated balance sheet.  The extra $3 trillion exists not only on the Fed’s balance sheet but also as excess reserves in the US banking system.  These excess reserves have the potential of being very inflationary should banks see substantially increased loan demand.  

Selling into the market, bonds bought many months ago at huge gains will help the deficit.  Although I cannot find data on this it would not surprise me if the Federal Reserve has an unrealized gain of about $300 billion.  Taking the gain would shrink the budget deficit to a very manageable amount for 2015.  It could even wipe out the deficit for the year.

From a portfolio manager’s perspective this is a win- win- win scenario.  Too bad Janet Yellen isn’t a portfolio manager.


Source: US Bureau of Economic Analysis, RIM
©Regions Bank, Member FDIC.  The foregoing represents the opinions of the author, Brian Sullivan, and not necessarily those of Regions Bank or Regions Investment Management, Inc. (RIM).  RIM provides commentary to clients of Regions Bank, an affiliated company wholly owned by Regions Financial Corporation.  The information contained in this report is based on sources believed to be reliable but is not guaranteed as to accuracy and does not purport to be a complete analysis of the security, company or industry involved.  Neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.  This report is designed to provide commentary on market strategy and the opinions expressed reflect the judgment of the author as of the date of publication and are subject to change without notice.  RIM assumes no responsibility or liability for any loss that may directly or indirectly result from the use of such information by you or any other person.  Investments discussed in this report are not FDIC-insured, not deposits of Regions Bank or its affiliates, not guaranteed by Regions Bank or its affiliates, not insured by any government agency, may go down in value, and not a condition of any banking activity.  Investment advisory services are offered through RIM, a Registered Investment Adviser.  RIM is wholly owned by RFC Financial Services Holding LLC, which in turn, is a wholly owned subsidiary of Regions Financial Corporation.

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