How a possible Yellen departure could spark a fire under the Fed to cut its $4.5 trillion balance sheet - Reuters

How a possible Yellen departure could spark a fire under the Fed to cut its $4.5 trillion balance sheet
Javier E. David | @TeflonGeek
11 Mins Ago
CNBC.com

It's often said that good things come to those who wait — but a bloated $4.5 trillion balance sheet might be a notable exception to that rule.
With the Federal Reserve facing a Herculean conundrum in unwinding its crisis-era monetary policy — and a likely leadership transition on the horizon — Goldman Sachssuggested on Saturday the central bank could move early to reduce the vast sums of government and mortgage-backed securities (MBS) it holds on its books.
In a research note to clients, the bank pointed to the likelihood that President Donald Trumpmay "reshape the leadership" of the Federal Open Market Committee (FOMC), the Fed's powerful policy-making body, as the terms of Fed Chair Janet Yellen and Vice Chair Stanley Fischer expire in early 2018.

"This could be important for balance sheet policy because many Republican-leaning economists have criticized quantitative easing (QE) and have expressed a preference for rapid balance sheet rundown, perhaps even through asset sales," wrote Daan Struyven, a Goldman economist.
If the new appointments—especially the new chair—are thought to favor aggressive balance sheet normalization, perhaps even including asset sales, and if all decisions are left up to the incoming team, financial markets might experience heightened uncertainty during the transition."
Goldman suggested there was a "strong 'risk management' case for an announcement of very gradual balance sheet runoff later this year," because of the political risk associated with new leadership at the Fed.
"Our forecast is that the discussion around reinvestment continues for most of this year and the plan is formally announced in December 2017," Struyven said. "At that meeting, we expect the committee to hold the funds rate steady after hiking in both June and September. We expect the quarterly hikes to resume in March 2018."
The economist harked back to 2013's "taper tantrum," in which markets reacted the Fed's suggestions of tighter monetary policy by sending bond yields surging and stocks reeling — albeit temporarily.
A potential fire sale of Treasurys and mortgage-backed securities by the Fed "could have significantly more adverse effects on financial conditions than gradual runoff, and the mere risk of such an outcome might set up another 'taper tantrum,' " Struyven added.
'The uncertainty is substantial'
As the central bank begins a campaign to tighten benchmark interest rates — making a quarter-point hike just last week — it's renewed a debate over how to unwind the Fed's massive bond buying program.

Some market observers have long argued that the Fed has distorted financial conditions with QE, and the central bank faces a huge task trying to pare down its bloated balance sheet.
"The bigger the Fed's credit footprint, the more it interferes with the efficient employment and pricing of credit," wrote George Selgin, a senior fellow and director of the Center for Monetary and Financial Alternatives at the libertarian-leaning Cato Institute, in a blog post last month.
"By directing a large share of savings to purchases of longer-term MBS and Treasury securities, for example, the Fed has artificially raised both the prices of those securities, and the importance of the housing market and the federal government relative to the rest of the U.S. economy," Selgin wrote. "It has also dramatically increased its portfolio's duration gap and, by so doing, the risk that it will suffer losses should it sell assets before they mature."
On Friday, Minneapolis Federal Reserve Bank President Neel Kashkari, the lone dissenter against the U.S. central bank's decision last week to raise interest rates, the U.S. economy is still falling short on employment and inflation.
Kashkari, an alumnus of both Goldman Sachs and the U.S. Treasury who oversaw the government's Temporary Asset Relief Program (TARP) during the financial crisis, believes the Fed should wait on raising interest rates until it publishes a detailed plan for how and when it will reduce its $4.5 trillion balance sheet.
Goldman set forth two scenarios under which the Fed could begin trimming its balance sheet. Under an "early start, passive runoff" scenario, the bank said the Fed "gradually tapers reinvestment in December 2017 over 10 months but does not sell assets."
Conversely, under a "late start, active sales" scenario, Goldman said the Fed could cease reinvesting in bonds in July 2018 "without tapering and actively sells $40bn of assets per month."
Under the latter, the Fed could shrink its balance sheet by about $250 billion per quarter starting in the second half of next year, "with similar contributions from maturing assets and active sales," the bank added.
However, neither scenario is without its risks, Goldman's economist wrote: "While our baseline estimate suggests relatively little tightening from balance sheet rundown, the uncertainty is substantial. The 2013 'taper tantrum' also provides a reminder that the impact of balance sheet policy on financial conditions is uncertain and could be larger than our baseline estimate."
--Reuters contributed to this article.

Former Marine Corps captain says Trump defense budget is 'less bang for more bucks' - CNBC News

Former Marine Corps captain says Trump defense budget is 'less bang for more bucks'
Jeff Daniels | @jeffdanielsca
Sat, 18 Mar '17 | 8:43 AM ET
CNBC.com

If Americans think more defense spending will make them safer they should think again, according to a retired U.S. Marine Corps officer who served in Iraq and Afghanistan.
"Just because you're spending more on the military doesn't mean we're going to have a more effective military force," said Dan Grazier, a former Marine captain and defense industry expert at the Project On Government Oversight, a Washington watchdog group. "That has proved true throughout history."
President Donald Trump's fiscal 2018 budget blueprint calls for a $54 billion increase in national defense spending, which represents an increase of about 10 percent over the sequestered levels.

"If President Trump wants to truly rebuild the military, he should actually slash budgets," Grazier wrote in a POGO blog post Friday. "It would force the Pentagon and Congress to make the difficult choices necessary to produce a more effective fighting force."
He notes that if the fiscal 2018 budget plan gets approved in Congress it would mean total defense spending of nearly $640 billion, which includes $65 billion for so-called Overseas Contingency Operations war funding. When combining other national security spending and veterans costs, the government outlays represent more than $1 trillion per year, Grazier said.
In the budget document, the Trump administration stated "this defense funding is vital to rebuilding and preparing our armed forces for the future."
The White House's budget request said "key investments in maintenance capacity, training systems, and additional F-35 Joint Strike Fighters would enable the Air Force, which is now the smallest it has been in history, to counter the growing number of complex threats from sophisticated state actors and transnational terrorist groups."
Yet Grazier contended that just throwing more money at defense isn't the answer because "it is just going to get flushed down the typical Pentagon spending holes." In an interview, he said what matters most is "how you spend it — and we do not have a track record of spending it well."
Grazier added, "Basically, the Pentagon and defense contractors and their allies in Congress want to throw a whole lot money at these really complicated [weapons] systems and spread the subcontracts around the country."
On his blog, Grazier wrote that defense budgets during the Obama administration peaked in 2011 and went "down incrementally in the years since, but they remained higher than at any time during previous administrations, including at the peak of the Reagan buildup in the 1980s."
"What did we get for those massive budgets? We didn't get more fighter planes. We didn't get more ships," he said. "Almost every day we are bombarded with dire warnings from services that the force is the smallest it has ever been. For some people, there will never be enough spending on the Pentagon."
Indeed, on Thursday Senate Armed Services Chairman John McCain (R-Arizona) criticized Trump's proposed top-line defense budget plan as simply not enough. He said in a press statement that the budget doesn't amount to the 10 percent increase as touted by the White House but is "a mere 3 percent over President Obama's defense plan, which has left our military underfunded, undersized, and unready to meet the threats of today and tomorrow."
According to Grazier, the Pentagon waste needs to be addressed and overhead too. Moreover, he believes there's a need to "reexamine a dependence on contractors that can cost as much as four times more than federal employees. But none of this will happen unless Congress forces these changes, and they can only do that by restraining budgets."
Grazier also said spending big money on some of the programs with a history of problems needs to be looked at more closely, including the F-35 stealth fighter, as well as the Navy's newest class of aircraft carriers, the Ford Class. Then there's the Navy's littoral combat ship program, which the U.S. Government Accountability Office in December concluded "has taken longer, cost more, and delivered less capability than expected."
"None of these systems are performing all that well," he said.
Trump recently visited the USS Gerald R. Ford super-carrier, built by Huntington Ingalls Industries for around $13 billion, or $2.5 billion over budget. The Ford-Class carrier program has a price tag of approximately $40 billion and there have been calls to scale back the program. Some critics suggest even the new carriers are vulnerable at sea.
The president wants to increase the Navy's fleet to 350 ships, up from today's force of 275 deployable battle ships. That will require the investment of nearly $700 billionover 30 years and there's some concern whether the shipyards can meet the goal due to shortages of skilled workers and other obstacles.
Grazier questions the decision by the Navy to use a new electromagnetic launch technology system for aircraft on the Ford-Class carriers instead of sticking with the steam-powered catapult system on the battle-tested Nimitz-Class carriers. Swapping out older systems has resulted in a "very large expense and the system does not work all that well yet," he said.
Meantime, the retired Marine officer also is critical of the F-35, a program projected to cost more than $1 trillion over its life cycle of about 53 years. He said the Pentagon's top weapons tester wrote a report detailing 60 pages of problems with the aircraft but it's essentially been ignored. 

Trump has been complained about the cost of the F-35 and suggested the possibility of replacing some of the F-35 purchases with the "comparable F-18 Super Hornet."Lockheed Martin built three variants of the F-35 Joint Strike Fighter, for the Air Force, Navy, and Marines.
The lot 10 deal for the F-35 was announced last month and cut the per-plane price on the F-35A (Air Force variant) to $94.6 million, or a 7.3 percent price reduction from the previous lot 9 terms. That marked the first time the F-35A had been below $100 million.
Even so, Grazier said the F-35 price still remains "vastly more expensive" compared with legacy fighters it is replacing. "We continue to get less bang for more bucks," he said. "Whether it's fighter planes or Navy ships or anything like that, they are always vastly more complicated than the one before. We spend more and more money for these things but we get fewer and fewer of them. So we keep getting these smaller and smaller forces."