SPXE - Federal Reserve Watch: Commercial Banks Have Lots And Lots Of Cash On Hand

2023-04-14 04:26:26 ET

Summary

• Investors still are not taking the Federal Reserve seriously about the tightness of monetary policy.
• The commercial banking system has $3.5 trillion in cash assets on banks' balance sheets and the financial system still seems to have plenty of money to spread around.
• The Federal Reserve may be reducing the size of its securities portfolio, but the liquidity already injected into the banking system may carry the banks for a relatively long time.
• Consequently, the price of gold, an indicator connected with inflation, is just below its historic high and looks likely to set a new high in the next few days.
• Maybe investors have been correct, the Federal Reserve is not really doing enough to stem the longer-term trend of inflation.

Last week was a very quiet week at the Federal Reserve.

It seems as if the most it did was to reduce some of the line items that were used to protect the banking system during March when the government had to deal with the bank failures and bank combinations that needed help at that time.

In terms of the Fed's quantitative tightening, this last week saw hardly any change in the Fed's portfolio of securities.

The reduction in the securities portfolio that began in the middle of March 2022 now totals $612.8 billion, or, if you include the adjustment for security premiums or discounts, the total reduction in the portfolio is $661.8 billion.

Basically, the week saw banks repay loans or other extensions made available to them during the early days of the bank problems. The transition, so far, back to a more normal environment has been smooth and steady.

So far, so good.

Investors Don't Take Federal Actions Seriously

The problem is that investors still do not seem to take the Federal Reserve's actions seriously.

That is, investors don't believe that the Fed is going to "stay the course" in its battle against inflation. Investors think the Fed is going to "pivot" or move in some other way so as to release the banking system from its clutches.

Where does this show up?

Well, Hardika Singh writes in the Wall Street Journal that "Gold Prices Near Record as Investors Bet Inflation Is Here To Stay."

"Gold prices hit their highest level of the year on Thursday."

"That also put it within striking distance of its record high reached in the summer of 2020."

On Thursday, April 13, 2023, the price of gold closed at $2,054.20 an ounce.

The all-time record price is $2,069.40 an ounce, reached in the summer of 2020.

Close.

Yes.

Very, close.

So how do you explain the price of gold nearing a historic high when the Federal Reserve is engaged in quantitative tightening, a program that has been going on since the middle of March 2022?

The Fed has also raised its policy rate of interest from 0.08 percent in March 2022 to 4.83 percent, currently.

Yes, that is what the Fed has done, yet investors have continued to question the Fed's staying power. The belief is that the Fed is going to back off... soon!

The Banking System Is Not "Tight"

One reason why the investment community might believe that the Federal Reserve is not really going to "tighten down" on the banking system is that there is so much liquidity in the banking system now and also in the financial system that investors don't really feel that conditions are "tight."

Looking at the Fed's own balance sheet, the H.4.1. statistical release titled " Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks", looking at the very first table, "Factors Affecting Reserve Balances of Federal Reserve Banks" and going to the line item "Reserve Balances with Federal Reserve Banks," we see that these reserve balances, on April 12, 2023, total $3,347.6 billion.

These reserve balances are often considered to be "excess reserves" in the banking system.

Wow!

$3.3 trillion in excess reserves.

And, the Federal Reserve has reduced these "excess reserves" in the banking system over the past year.

One can see these reserves heading down more rapidly after March 2022.

One can also see, over the last four weeks of the chart the "liquidity" the Fed allowed into the commercial banking system to protect the banking system from the failure and other traumas taking place in March.

Note, though, at their peak, these excess reserves in the banking system totaled more than $4.2 trillion!

How does these numbers stack up with the statistics on the commercial banking system?

Well on March 29, 2023, commercial banks in the United States held $3,459.0 billion or $4.5 trillion, in cash assets. This is from the Federal Reserve statistical release H.8, "Assets and Liabilities of Commercial Banks in the U.S."

So the two sets of numbers are not too far off from one another.

Given this result, one of the questions I have is about the use of cash assets in the banking system over time.

On March 29, 2023, the commercial banking system had $3,459.0 billion in cash assets.

One March 18, 2020, there were $2,047.2 billion in cash assets. On March 17, 2010 the commercial banks held $1,229.7 billion in cash assets. On March 16, 2005 the total cash assets were $346.5 billion and on March 15, 2000, cash assets totaled $269.1 billion.

Go back a little further and the number drops below $100.0 billion.

It seems as if commercial banks keep a lot more cash on hand than they used to do in the past.

What's going on?

There seem to be lots and lots of cash assets around the U.S. financial system.

The central bank seems a lot more comfortable when the banking system has cash assets on hand than otherwise.

One can ask, is this a consequence of the Fed's operating policies over the past twenty years or so?

It looks like commercial banks are keeping more "excess reserves" on hand than they did moving into the late 2010s and early 2020s.

Did all the turmoil in the economy and the banking system due to the Covid-19 pandemic and subsequent recession have something to do with this?

Could it be that we have had more than a full year of the Fed's quantitative tightening, and yet the commercial banking system, as a whole, has lots and lots of "cash" hanging around.

And, as a consequence, the financial system, itself, feels more that supplied with liquid assets.

And so the market plays go on and on and on.

Yes, the Federal Reserve has reduced its securities portfolio by over $660.0 billion dollars.

Yes, reserve balances with Federal Reserve banks have declined by more than $545.0 billion.

Yet, there is almost $3.5 trillion in cash assets in the commercial banking system.

Doesn't seem like the banking system is strapped at all.

And so investors don't see the Federal Reserve really tightening up as much as they might need to in order to really fight inflation.

The banking system is bursting with liquidity.

Only banks that have really gone off the deep end, like Silicon Valley Bank and Signature Bank, are in real trouble.

Gold, A Leading Indicator

So, is the price of gold a leading indicator?

An indicator that the investment community believes that there is enough money on hand that the price of gold will rise to a new historic high!

This is the inconsistency we see in the financial markets when we hear the Federal Reserve saying that they are tightening up on the banking system to fight inflation, but the price of gold goes to historic highs, the price of stocks seem to want to rise, and spending in the economy seems sufficient enough to keep the unemployment rate at a 66-year low.

Maybe monetary policy is not really tight enough to put a squeeze on people.

Maybe the monetary authorities are just fooling themselves.

Maybe.

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