RTX - Federal Reserve Watch: Use Of The Reverse Repurchase Market Is Declining

2023-11-17 15:35:40 ET

Summary

• The Federal Reserve has reduced its securities portfolio by $30.3 billion in the latest banking week.
• The total reduction since the start of quantitative tightening in March 2022 is now $1.18 trillion.
• A chart illustrates the gradual decrease in the size of the Fed's securities portfolio.
• But other things are happening as the commercial bank use of the Reverse Repo facility drops precipitously.

The Federal Reserve reduced the size of its securities portfolio by another $30.3 billion in the banking week ending November 15, 2023.

This brings the total reduction to $1,182.6 billion, or, $1.18 trillion since the Fed began conducting its policy of quantitative tightening on March 16, 2022.

Here is what the chart looks like.

More and more, however, I want to divide this period of time into two segments. The first is the segment of time when the Federal Reserve was primarily reducing its securities portfolio while raising the Fed's policy rate of interest on a regular basis.

During this time period, the Fed was reducing the amount of Reserve Balances with Federal Reserve banks, helping to reduce the liquidity in the banking system while supporting the rise in the Federal Funds rate.

I have often referred to the account Reserve Balances with Federal Reserve Banks as "excess reserves." And, during this time "excess reserves" in the banking system were shrinking as the Federal Funds rate rose.

Check these charts out.

Note, that "excess reserves" totaled $3,893 billion on March 16, 2022, and fell by $865 billion to rest at $3,028 billion on March 1, 2023.

This represented quite a drop in bank liquidity.

The Fed's policy rate of interest, the Federal Funds rate took this path during this time.

So, this gets us through the first part of the time period.

From March 1, 2023, to the current date, "excess reserves" in the banking system moved from $3,028 billion to $3,483 billion on November 15, 2023. This represents a RISE in "excess reserves" of $455 billion.

What happened during this period of time?

Well, in the first weeks of March 2023, several sizeable commercial banks were announced as being in trouble. The Federal Reserve had to respond and it apparently responded by stopping the decline in "excess reserves' and by stabilizing them over the next eight months.

"Excess reserves" in the banking system, as can be seen, have actually risen from early March to the present time.

The Federal Funds rate? What happened here?

The Federal Reserve continued to raise its policy rate of interest during this time period, but only made three more movements.

What changed? How did the Fed act differently in the two different time periods?

Well, let's look at the account titled "Reverse Repurchase Agreements."

When the quantitative tightening began, reverse repurchase agreements amounted to $1,865 billion, a pretty sizeable amount. Yet, up until March of 2023, this account was very active rising to $2,500 billion on the Fed's balance sheet.

So, while the Fed was going through the early stages of quantitative tightening, commercial banks used the Fed's "reverse repo" account to sell, under an agreement to repurchase, a total amount of $2.5 trillion.

The "reverse repo" window was used by the Fed to help the commercial banking system work through the steady reduction in the Fed's portfolio of securities held outright.

So, the Fed was tightening up on the banking system by reducing the size of its securities portfolio, but was also allowing the banking system to protect its reserve system by accessing the "reverse repo" market.

But, what has happened since March 1, 2023?

Since March 1, 2023, reverse repurchase agreements on the books of the Federal Reserve have fallen by $1,233 billion or, by approximately, $1.2 trillion.

Here is the chart.

So, what is the Federal Reserve going to do now?

Because of the reduced pace of consumer price inflation, many analysts are picturing an end to the rise in interest rates. Some are even calling for a decline in the Fed's policy rate of interest in 2024.

To me, that really is not the issue.

The issue, to me, is the amount of securities that the Federal Reserve holds on its balance sheet and the "overuse" of the reverse repo account.

I would like to see the amount of securities on the Fed's balance sheet come down by at least another $1.0 trillion if not more.

And, I would like to see the usage of the Fed's reverse repo account come down. Personally, if the Fed's securities portfolio comes down by another $1.0 trillion, I would like to see the reverse repo account drop by another $1.0 trillion.

I believe that the Fed needs to accomplish moves like these in the near term to get its balance sheet back to something one could call "more normal."

We need to get back to the "more ordinary" so that market participants and analysts can return to a world that they are more used to and understand better.

However, this may still take some time to accomplish.

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