TPSC - Federal Reserve Watch: Quantitative Tightening Continues

2023-03-31 03:23:21 ET

Summary

• In the past two weeks or so, the United States has experienced bank failures, Europe has experienced bank problems, and there is word that more may be in the future.
• Last week the Fed raised its policy rate of interest.
• Furthermore, the Fed continues to oversee its program of quantitative tightening, and the Fed's securities portfolio continues to decline.
• So far the Fed has managed through all the disruptions and financial markets remain calm.
• Radical uncertainty still shadows the future as the Fed continues to fight inflation and works to help keep the commercial banking functioning.

While all the noise is going on about the recent bank failures and the Federal Reserve's efforts to continue to raise its policy rate of interest, it is important for us to continue to look at what the Federal Reserve is doing about its securities portfolio.

In the latest banking week, the one ending Wednesday, March 29, 2023, Federal Reserve officials oversaw the securities portfolio decline by another $11.1 billion. This is from the Federal Reserve release H.4.1, "Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks."

Since, March 8, 2023, just before the news about the failure of Silicon Valley Bank broke (March 10), the Fed's securities portfolio has fallen by $23.8 billion.

The March decline is not as much as has been experienced in other months, but the Federal Reserve has continued to oversee that the securities portfolio has continued to decline.

Overall, since March 16, 2022, when the Fed's current round of "quantitative tightening" began, the securities portfolio has declined by $612.0 billion.

Not too shabby.

Note the steady progress.

But, this is not all that was happening to the Fed's balance sheet, and it especially was not all that was happening to the amount of "excess reserves" held by the commercial banking system.

A "proxy" for excess reserves in the banking system is the line item titles Reserve Balances with Federal Reserve Banks. This item gives us an indication of how much liquidity is in the commercial banking system and how the "excess reserves" in the banking system are being manipulated so as to support the level of interest rates the Federal Reserve is trying to achieve.

It is not surprising that these Reserve Balances increased in the past week, and have increased over the past three weeks as the banking turmoil increased the financial markets.

In the latest banking week, Reserve Balances rose by $31.8 billion and over the past three weeks, Reserve Balances rose by $364.0 billion.

Note that since the Federal Reserve started its quantitative tightening, Reserve Balances have dropped by $491.6 billion.

So, one can see that although the Federal Reserve has maintained a steady decrease in the size of the Fed's securities portfolio, Federal Reserve officials have had to manage the markets more closely in order to support the interest rates levels it was trying to maintain.

Over the past three weeks we can therefore see that reserves had to be put back into the commercial banking system to keep the Fed's policy rate of interest from rising even higher than it now stands.

Once the banking turmoil ceases, the Fed will have to oversee a reduction in the "excess reserves" so as to keep the policy rate from falling.

Here is a look at how these Reserve Balances have performed since March 16, 2022.

Notice the big jump upwards at the end of the chart.

Before these recent movements, the Federal Reserve has seen these Reserve Balances fall fairly steadily.

And, the Fed's policy rate of interest? Here is the chart on the effective Federal Funds rate since March 16, 2022.

So far, it looks as if the Federal Reserve is sticking to its objectives and working in the financial markets to "steady" the disruptions caused by the recent bank failures and all that has surrounded them.

In order to maintain this posture, the Federal Reserve has had to use a variety of tools. Overall, the Fed has been helped by the movement of the funds of the U.S. Treasury Department's General Account and it has made major use of the Fed's reverse repurchase facility.

In the past couple of weeks, the Fed has used in discount window to see that the money markets had sufficient funds and it has also made use of its repurchase agreement facility.

The Fed has a lot of tools and so far has used quite a few of them.

The important thing is that Fed officials have kept their eyes on the goal that they set out to achieve and have done a pretty good job of managing the situation so as to achieve their goals while at the same time keeping the financial markets calm.

This is not always a very easy task.

Going forward, I am not sure that the Federal Reserve will find the task any easier.

We have government debt issues coming up, we have private debt issues coming up and we have world conflicts that add market difficulties to the menu. And, we have no real idea about how bad the banking crisis might turn out to be.

What else could there be?

Not only known unknowns but what about the unknown unknowns?

This is where the Federal Reserve now finds itself.

For further details see: