VTI - Federal Reserve Watch: Fed Raises Policy Rate And Keeps Reducing Portfolio

2023-05-05 09:23:12 ET

Summary

• The Federal Reserve raised its policy rate of interest this past week, but investors now think that this will be the last raise for a while.
• The Fed continues to oversee the shrinkage of its securities portfolio, keeping up a steady decline over time.
• The Fed did oversee a rise in bank liquidity this past week, maybe in continued response to the trauma still present in the commercial banking system.
• How long will the Federal Reserve keep this up? We really don't know. Keep watching!

Well, the Federal Reserve did what everyone was expecting them to do.

They raised their policy rate of interest by 25 basis points. Now the policy range runs between 5.00 percent and 5.25 percent.

This was the tenth increase in the policy rate since the Fed began to raise the rate last March.

There is a feeling that the Fed will back off from raising the policy rate again in the near future. The next meeting of the Federal Open Market Committee is set for June 13-14.

In the statement the Federal Reserve released following the FOMC meeting and in talk after the meeting, two things were stressed.

First, the Federal Reserve stressed how important it was for it to achieve its goal of bringing the rate of inflation down to 2.00 percent.

Second, the Fed emphasized that they would continue to watch the data coming in to determine what further Fed actions would be needed in the future.

Many interpreted this second part of the message as a signal that the Fed would not move the policy rate any further in June.

The Response

Following the announcement, the stock market declined.

The S&P 500 Index (SP500) dropped about 29 points on Wednesday and then followed this up with a 30-point decline on Thursday.

Furthermore, on Wednesday the price of gold rose about $18 per ounce closing at $2,044.30 per ounce.

On Thursday, the price of gold closed at $2,058.00 per ounce. This is quite near the historic high for the price of gold.

These were not exactly the results that Federal Reserve officials were expecting from their move.

Many investors still feel that the Federal Reserve leadership is going to "pivot" soon and get off their stance of monetary tightening.

Quantitative Tightening

The Federal Reserve still continues to oversee the decline in its securities portfolio.

The securities held outright at the Federal Reserve declined by $43.1 billion in the banking week ending May 3, 2023. These data are taken from the Federal Reserve statistical release H.4.1, "Factors Affecting Reserve Balances of Depository Institutions."

The complete decline came in the Fed's holdings of U.S. Treasury securities.

Now, the decline in the securities portfolio looks like this.

Overall, since the middle of March 2022, the securities held outright by the Federal Reserve have dropped by just over $740 billion.

In this part of the monetary tightening program begun by the Fed, the central bank has done a pretty good job. And, like the other "quantitative" programs it has engaged in, the change in the securities portfolio has been very steady.

Reserve Balances With Federal Reserve Banks

With respect to the excess reserves that exist within the banking system, this past banking week saw a rise in bank liquidity.

Reserve balances with Federal Reserve banks rose by just over $34 billion.

Reserve balances with Federal Reserve banks, after falling fairly regularly since March 16, 2022, rose dramatically in the early part of March 2023 as the banking system experienced two bank failures.

As reported last week, the Fed had seen these excess reserves move off the Fed's balance sheet as the banking system seemed to stabilize.

However, on Monday morning it was announced that JPMorgan Chase & Co. (JPM) was taking over First Republic Bank (FRCB).

The reserve balance with Federal Reserve Banks rose, apparently to help with the acquisition.

Here is what the chart looks like.

You can see the recent rise in these "excess reserves" on the right-hand side of the chart.

Summary

So, it looks as if the Federal Reserve is staying "right on track" in its fight against inflation.

Of course, everyone is waiting to see what happens next.

Mr. Powell, the Federal Reserve chairman, continues to present a picture of the Fed staying on course to get the rate of inflation down to the Fed's target of 2.00 percent.

Although the rate of inflation in the United States has continued to decline, the year-over-year rate of inflation of the Fed's target index remains around 4.5 percent. So, there is still a way to go.

And, as mentioned above, it seems as if many market participants have their doubts about whether or not Mr. Powell will "stay the course."

In the foreign exchange market, the value of the U.S. dollar continues to remain weak.

As I have reported regularly in recent months, it appears as if lots and lots of money is flowing out of the U.S. dollar. And, talk of de-dollarization continues to stay around.

This is not good.

But, this is what Mr. Powell and the Federal Reserve have to deal with right now.

I particularly suggest that interested investors keep a close eye on what the Fed continues to do with its securities portfolio.

Any break in the quantitative tightening will be a real reason to think that maybe Mr. Powell and the Fed are really "pivoting" from the tight money posture.

This would be major!

For further details see: