SPUS - Federal Reserve Watch: Returning To Plan

2023-04-21 04:36:44 ET

Summary

• It appears as if the banking disruptions started in early March 2023 have reached an end and the Fed can return to its previous fight against inflation.
• The Federal Reserve has begun reducing the "liquidity" it provided the banking system to stop the "bank runs" and subsequent bank failures.
• The Fed has also continued to reduce the size of its securities portfolio so that quantitative tightening continues.
• The concern that exists is about whether or not the Federal Reserve is actually removing the amount of securities its needs to remove in order to seriously tighten up on the banking system.
• We are still in a world of radical uncertainty where there remain a lot of "unknown, unknowns" that are going to have to be dealt with.

It looks like the Federal Reserve is returning back to plan... the plan to reduce inflation.

The Federal Reserve continued to reduce the size of its securities portfolio.

In the week ending April 18, the securities the Federal Reserve held outright fell by $17.3 billion.

The Fed has not stopped letting securities runoff from its portfolio.

But, the Federal Reserve also oversaw reserve balances with Federal Reserve banks, something I have associated with the excess reserves held by commercial banks, which dropped by $182.7 billion ending the April 18 banking week at $3,164.9 billion.

During the period running from March 8 up to the present time, the Federal Reserve saw to it that the banking system had plenty of liquidity.

In effect, reserve balances with Federal Reserve Banks jumped from a little over $3.000 trillion in the banking week ending March 8, to $3.444 trillion in the banking week ending March 15.

It was in the banking week following March 8 that the financial problems of Silicon Valley Bank and Signature Bank surfaced and had to be dealt with.

The Federal Reserve, as can be seen, immediately jumped into the turmoil and provided sufficient liquidity to the banking system so that the bank failures coming to the surface could be managed and the banking system could be kept functioning.

As can be seen, the liquidity injections coming in the banking week ending March 15 seemed to be sufficient to put a stop to any further run on the banking system.

Although the amount of reserve balances with Federal Reserve Banks remained in a relatively narrow range in the following weeks ($3,401 billion to $370.0 billion) the only real move to lower these balances came in the banking week just ended when these excess reserves fell by $182.7 billion.

If one is looking for a possible signal that the banking system is getting over its "scare" that the amount of bank failures might immediately skyrocket, this decline, hopefully, is that signal.

These reserve balances with Federal Reserve banks still need to fall by another $340.0 billion to return the excess reserves of the banking system back to where it was at the start of March, but, it seems as if one can certainly say that the Fed is moving back to its "fight inflation" game plan.

Quantitative Tightening

In terms of quantitative tightening the Federal Reserve steadily on.

As mentioned above, the Federal Reserve's securities portfolio declined by $17.3 billion in the last banking week. This continues the decline in the portfolio that began in the middle of March 2022.

It should be noted that this curve looks just like the inverse of the quantitative easing curves that the Fed created in before 2022.

And, the current "tightening" curve is reaching the length that the quantitative easing curves reached.

So, one can say that in terms of sticking to its program of quantitative tightening, the leaders of the Federal Reserve have certainly stuck by their promises.

The big question mark concerns the amount of reduction in the securities portfolio that has been achieved.

Since March 16, 2022, the amount of securities held outright has declined by right around $630.0 billion.

Has this been enough of a reduction?

I have been arguing in recent posts that this amount of reduction is not nearly enough to really achieve the reduction in inflation that the Federal Reserve would like to achieve.

As noted in many of my recent posts, a reduction of only $630.0 billion in the securities portfolio is not close at all to the amount of securities that the Federal Reserve added to its portfolio in 2020 and 2021.

As a consequence the commercial banking system has more than enough cash on hand to generate very good operating performances.

Just look at the results the six largest banks in the country generated in the first quarter of 2023. I have just discussed these results in my last three posts here on Seeking Alpha.

JPMorgan Chase & Co. led the effort turning in an 18.0 percent return on equity.

The other five did very well.

The performance of these banks is a result of all the cash the Fed threw into the banking system in order to fight the effects of the spread of the Covid-19 pandemic.

Now, investors, and the Federal Reserve are having to deal with is left over from the asset bubble the Fed created at this earlier time.

And, it looks as if the Federal Reserve may still have a lot of work to do.

How much further is the Fed going to have to reduce its portfolio to gain control, once again, of the commercial banking system... especially the largest banks in the system?

No one has any idea what this number might be.

So, the Fed is just going to have to keep with its quantitative tightening and find out where the tightening is really going to hurt.

Interest Rate Rise

The Fed's next meeting of the Federal Open Market Committee is on May 2 and 3.

Right now, it seems as if the leaders of the Federal Reserve are confident enough that they will raise the Fed's policy rate of interest by another 25 basis points.

That will keep the program going.

After that?

Well, that is going to depend upon how Fed Chair Jerome Powell and other members of the FOMC, feel about what the Fed has achieved and what it still needs to achieve.

Frankly, I don't think that Mr. Powell and the Federal Reserve has done enough. Tightening needs to go on further.

And, I am not sure that quantitative tightening is the way to do it. But, more on that later.

Right now, it looks as if the "banking disturbance" is over for the time being. The Federal Reserve can then "keep on, keeping on" with its reduction of its securities portfolio.

I am just afraid that this is not the end of the radical uncertainty we are experiencing.

For further details see: