Summary
- The Federal Reserve is continuing to remove securities from its securities portfolio, supporting its efforts to increase its policy rate of interest.
- The Federal Reserve has continued to reduce its securities portfolio much in the same way it increased its securities portfolio in the period of quantitative easing in the 2020-2022 period.
- The real question that investors should be asking is, "How long will the Federal Reserve continue to oversee a reduction in its securities portfolio?"
The news that reaches us is still about the Fed's policy rate of interest.
Will it be raised by 25 basis points or by 50 basis points?
How much longer will the increases continue?
Just how high will the effective Federal Funds rate rise?
And, the news is all over the place.
Still, the Federal Reserve continues on its quantitative tightening, much as it carried on its quantitative easing at an earlier time.
And, Federal Reserve officials stay true to their earlier policy statements... the quantitative tightening will continue for quite some time.
In the latest banking week, the Federal Reserve oversaw a decline of $39.5 billion in its securities portfolio.
Thus, since March 16, 2022, the securities portfolio has declined by $587.9 billion.
Thus we see a steady, persistent decline in securities held outright.
But, to support the rising Federal Funds rate, Federal Reserve officials have allowed the "excess reserves" held by the banking system to decline by even more than this.
The line item in the Fed's balance sheet (the H.4.1 statistical release) titled "Reserve Balances with Federal Reserve Banks" serves as a close proxy for the "excess reserves" held by commercial banks.
These reserve balances have decreased by $865.4 billion since March 16, 2022.
Reserve Balances With Federal Reserve Banks (Federal Reserve)
Note that the decline in this series has been rather erratic, and not smooth and steady like the series in the first chart, the chart on securities held outright.
The reason for this erratic movement in "excess reserves" is that the Federal Funds rate is impacted by many things going on with the Fed's balance sheet.
One of the major influences on bank reserves is how the U.S. Treasury Department is managing its "General Account," the account that the Treasury Department uses to make payments into the economy.
The Federal Reserve is using its "reverse repurchase agreement" account to keep the money markets calm and allow the Federal Funds rate to remain level at its current "policy" rate.
The effective Federal Funds rate can, therefore, remain steady even though the money markets are less than steady. And, the Fed can continue to reduce the size of its securities portfolio in the steady, persistent path it has followed.
Impact On The M2 Money Stock
The Federal Reserve's actions are impacting the M2 Money Stock.
The M2 money stock reached its recent monthly peak in May 2022.
In January 2023, the year-over-year rate of decline in the M2 money stock was 1.7 percent.
Year-over-year, the M2 money stock has been declining for five months now.
Historical research shows that a slowdown in money stock growth impacts the economy with a long and variable lag.
So, all the pieces seem to be in place for the U.S. economy to go into a recession.
Importance Of Quantitative Tightening
The most important thing in this narrative is that the Fed continues and will continue quantitative tightening.
I think that the first chart in this post tells us the story.
But, let's look at the quantitative easing that Chairman Powell and the Federal Reserve conducted to combat the Covid-19 pandemic from May 6, 2020, to March 2, 2023.
This period of quantitative easing lasted almost 21 months!
The current period of quantitative tightening has not lasted one year.
How long will the Fed continue to let the securities portfolio decline?
The quantitative easing under Mr. Powell lasted much longer than anyone expected.
Might Mr. Powell allow the quantitative tightening to go on for 20 months?
My real point is that analysts and investors should be focusing upon what the Fed is doing with respect to its quantitative tightening. That is where the "real" action is.
That is where we are really going to find out whether or not the Federal Reserve is doing enough to remove all of the reserves it pumped into the economy at the earlier date.
For further details see:
Federal Reserve Watch: Quantitative Tightening Still Continues