Federal Reserve Chairman Ben Bernanke
Federal Reserve Chairman Ben Bernanke Reuters

The Federal Reserve has become the largest Treasury holder in the world in Q1 2011 at $1.34 trillion.

That’s more than China ($1.14 trillion) and US households ($959.4 billion). It’s also 9.4 percent of the total size of the $14.27 trillion Treasuries market in Q1 2011.

So just how large is $1.34 trillion / 9.4 percent of the total market?

The answer is it’s not catastrophically big.

Yes, the Fed holds more than China (the largest foreign holder) and US households. However, it’s smaller than the holdings of the US Social Security Trust Fund and much smaller than all foreign holders combined.

Moreover, individual stocks and commodities routinely have players who control more than 9.4 percent of the market. For example, the US Treasury owned 27 percent of Citigroup (NYSE:C), which it subsequently sold to the market. The last shares were sold in December 2010.

However, that didn’t prevent investors from scooping up Citigroup shares during that time. Indeed, share prices more than quadrupled from March 2009 to December 2010.

The truth is that the 9.4 percent Federal Reserve ownership is not the end of the world. Instead, there are much more serious matters at hand for the Treasuries market than QE2.

The biggest issue, by far, is government spending in the long-term. The second biggest issue is how well the US economy performs. A third issue is tax policy.

If the US government cuts spending and collects decent tax revenues, investors will be confident it can pay off its debt with minimal inflation and therefore be bullish on Treasuries. If the opposite happens, investors will expect the US government to inflate its way out of debt and therefore be bearish on Treasuries.

The only way QE2 will matter is if the Federal Reserve rolls at QE3, QE4, etc, which is a highly unlikely outcome. Jeffrey Gundlach of DoubleLine Capital said as much when he opined that the end of QE2 is bullish for the Treasury market because that’s likely all the purchases the Fed will do. So as long as it stops at QE2, QE will be nothing more than an afterthought in the Treasuries market a few years from now.