VTI - Federal Reserve Watch: Fed Needs To Do More

2023-07-14 11:47:58 ET

Summary

• The Federal Reserve continues on its path of quantitative tightening and higher interest rates.
• However, other central banks around the world seem to be out-doing the Fed and, as a consequence, the value of the U.S. dollar has fallen.
• The Federal Reserve needs to be more restrictive and move its policy level to where the value of the U.S. dollar is maintained in a relatively stronger position.
• The federal government needs to adjust its budgetary policies so as not to be working against what the Federal Reserve is trying to achieve.

It seems as if other central banks, like the European Central Bank, believe that they must keep money on the tighter side for a longer time period than the Federal Reserve System.

Olaf Storbeck writes in the Financial Times that:

"Some Eurozone rate-setters believe more interest rate rises will be necessary after the summer amid concerns that inflation was staying 'too high for too long,' according to an account of last month's monetary policy decision."

"The minutes of the June meeting of the 25-member governing council...supports economists' expectations that interest rates could need to keep rising to tame persistent inflation."

"The central bank last month increased borrowing costs by 25 basis points to 3.5 percent, the highest level in 22 years--and signaled that an increase of similar magnitude was likely at its next meeting on July 27."

The impacts of the relatively tighter monetary policy elsewhere around the globe have kept the value of the U.S. dollar falling.

Investors have seemingly had this attitude since late September of 2022 , when the value of the U.S. dollar began to decline.

As can be seen, the value of the U.S. dollar, relative to the euro, began rising right around the time that the Federal Reserve started raising its policy rate of interest and began its effort at quantitative tightening. This was in the middle of March 2022.

In late September of 2022, as other central banks around the world, including the European Central Bank, started to raise their policy rates of interest as well, the value of the U.S. dollar, relative to the euro, began to fall.

With this action, investors sent a signal that the Federal Reserve, although it was tightening up on its monetary policy, was not doing as much as it could relative to what other central banks were doing. The market seemed to be crying for the Fed to tighten up even further so as to at least keep the U.S. dollar from declining at all.

The U.S. central bank continues to disappoint the world in this respect.

Jay Powell, the Federal Reserve chairman, and the rest of the leaders at the Federal Reserve, seem content to let this be the case.

Current Federal Reserve Actions

The Federal Reserve continues to let its securities portfolio shrink and continues to talk about further increases in its policy rate of interest.

The Federal Open Market Committee, the policy-making group of the Fed, has its next two meetings on July 25 and 26 and on September 19 and 20.

Expectations are for the FOMC to raise its policy rate by 25 basis points at least once, maybe twice, during this time period.

In terms of its efforts at quantitative tightening, the Federal Reserve continues to see its securities portfolio decline.

During the past banking week, the week ending Wednesday, July 15, the Fed saw its securities portfolio decline by only $2.1 billion. However, since June 28, the securities portfolio has fallen by almost $41.0 billion.

Since the start of this effort, March 16, 2022, the securities portfolio has fallen by $845.7 billion while another $56.7 billion was wiped off the Fed's balance sheet as the net premiums of these securities were also written off.

This accounts for a reduction in the securities of the Fed by just over $900.0 billion.

However, the Fed has managed its balance sheet to support the changes in its policy rate of interest. The important line item on the Fed's balance sheet in this case is called "Reserve Balances with Federal Reserve Banks." This item is roughly equivalent to the "excess reserves" carried by commercial banks.

Note that since the middle of September 2022, this series has remained above $3.0 trillion.

As can be seen, the level of "reserve balances" rose in the first week of March 2023 as the Fed supported the banking system as Silicon Valley Bank and two other regional banks failed or were acquired.

So, in terms of the Fed tightening up on monetary policy, the level of "excess reserves" in the banking system actually stalled and then rose since the middle of September 2022.

This, as was mentioned above, was the exact same time that the rise in the value of the U.S. dollar stopped, followed by a decline in the value of the U.S. dollar up to the current time.

The Federal Reserve was continuing its quantitative tightening, but...but...but...the Fed was using the other accounts to manage the liquidity in the banking system.

For example, in the banking week ending July 12, 2022, the Federal Government increased its deposits with the Fed by $63.2 billion. During the same week, the Fed saw the amount of Reverse Repurchase agreements on its balance sheet fall by $43.5 billion.

And, since March 16, 2022, Federal Government deposits declined by $206.9 billion while Reverse Repurchase agreements offset this drop by increasing $283.2 billion.

So, a lot of other things are happening on the Fed's balance sheet that help the Fed manage the decline in the amount of securities it holds outright.

And, as we see from the last chart, even though the Fed is allowing its securities held outright portfolio to decline in a persistent fashion, the liquidity in the banking system, as measured by the "excess reserves" the commercial banks carry, is being managed by Federal Reserve officials so as to support the level of the Fed's policy rate of interest at the level desired.

Conclusion

The Federal Reserve continues to follow its quantitative tightening path.

The Federal Reserve continues to raise its policy rate of interest.

The value of the U.S. dollar falls.

To me, the Federal Reserve is not doing enough to support the value of the U.S. dollar.

To me, the government should not be allowing the value of the U.S. dollar to fall.

Of course, the federal government is pursuing budgetary plans that counter what the Fed is doing.

This is not helpful at all and, I would say, is even counterproductive to what needs to be done to stabilize the economy and the financial markets.

Investors should continue to monitor the movements in the value of the U.S. dollar and see how the markets are grading the efforts of the Federal Reserve...and the federal government.

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