Here we are in the third month since the Federal Reserve declared that their program to withdraw all the liquidity they had injected into the banking system was at an end. Of course, during the exit program excess reserves in the banking system rose substantially as total reserves and the monetary base continued to rise.
Now the Fed is engaged in a “non-exit” strategy with many analysts believing that the second round of quantitative easy will begin on Wednesday, the day after the mid-term elections. (No politics here!)
In preparation for any changes in monetary policy that might take place in the near future, we still need to get current with how the Fed has been behaving in the recent past.
Over the past thirteen-week period, the Excess Reserves held by commercial banks have declined by about $40 billion. This is consistent with the figures derived from the Federal Reserve data on the Federal Reserve’s H.4.1 release “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks.” In terms of the actual data for the end of the banking week, the comparable figure, reserves with Federal Reserve Banks also declined by about $40 billion over the past thirteen weeks.
Over the past four-week period, however, the reserve balances at Federal Reserve banks rose by more than $26 billion, a number we shall examine below. The excess reserves held by banks also rose over this time period.
The banking system still remains very liquid although this seems to be just what the commercial banks want.
In terms of the money stock statistics, monetary growth actually increased at a relatively steady pace over the last thirteen weeks. The most closely watched measure of the money stock, the M2 measure, was rising at a year-over-year pace of 1.8% in July 2010. This year-over-year rate of growth increased to 2.8% in September and stands at about 3.0% near the end of October.
The year-over-year growth rate of the M1 measure of the money stock has also increase steadily into the fall. In July 2010, M1 was increasing at a 4.7% rate. This rose to 5.9% in September and was around 6.3% at the end of October.
Money stock measures are showing steady rates of increase and this is good.
The steady increase in the money stock measures seems to have been little affected by the transactions going on within the Federal Reserve’s balance sheet, and this is good.
The questions that need to be asked is what happened on the Fed’s balance sheet and why?
The first series of questions relates to the $40 billion decline over the past thirteen weeks in the reserve balances held by commercial banks in Federal Reserve banks.
This decline primarily comes from three sources. The first source is a rise in Currency in Circulation of over $19 billion. A movement like this reduces reserve balances as coin and currency is withdrawn by the public from commercial bank accounts. In the last three months the year-over-year rate of growth of currency held by the public has increased from 3.8% to 4.0% to 4.4%. This figure is high relative to the five years before the financial collapse in the fall of 2008 and the fact that it is rising is something to pay attention to. Currency in circulation does not usually go up in the fall season relative to July and August because cash needs are usually high in vacation periods but not in the fall when coin and currency is returned to the banking system.
The demand for cash can rise as people having financial difficulties transfer their wealth into cash balances so that they can pay for the necessities of life. This is not good.
Note that of the $19 billion increase over the last thirteen weeks, almost $9 billion of the increase came just in October. Keep a watch on this number.
The second source of the decline in reserve balances came from accounts on the Fed’s balance sheet related to “bail out” items. Almost $17 billion left the Fed’s accounts related to a decline in these “special” accounts. The Fed plans to allow these accounts to run off as these assets are worked out. Hopefully these accounts will continue to decline at a relatively steady pace.
The third source of decline came in the Fed’s portfolio of securities: specifically, the Fed’s portfolio declined by a little more than $15 billion in the thirteen weeks ending October 28, 2010. Of interest is the fact that the holdings of Mortgage-backed securities declined by more than $66 billion and the holdings of Federal Agency securities declined by almost $10 billion, a total of about $76 billion. The Federal Reserve replaced $61 billion of these securities through the acquisition of U. S., Treasury securities.
Note that the Fed is doing pretty much what it said it would do in this regard. The Fed said that as the portfolio of Mortgage-backed securities and Federal Agency securities declined, it would seek to offset this decline by the purchase of Treasury issues. This is another area that bears close attention in the up-coming weeks.
Finally, we look for an explanation of the $26 billion increase in Reserve Balances at Federal Reserve banks over the past four weeks. The primary mover here is operational in nature. The General Account of the U. S. Treasury at the Federal Reserve declined by about $31 billion during this period. This puts reserves back into the banking system. A movement in this account is usually associated with writing of checks at the Treasury, reducing tax monies that have been collected in the past. The Federal Reserve knows that a movement like this is going to take place and is therefore prepared to deal, operationally, with this drain on its balance sheet.
Very little change took place related to factors supplying reserve funds to the banking system. However, the Federal Reserve continued to see its portfolio of Mortgage-backed securities run off during this period (the portfolio declined by almost $28 billion) and Federal Agency securities (a $4 billion decline) run off. This run off was countered by purchases of U. S. Treasury securities which increased this part of the Fed’s portfolio by $26 billion.
The net decline in the securities portfolio was offset by other small movements in accounts so that factors supplying funds to bank reserves was relatively insignificant.
My interpretation of the actions of the Federal Reserve over the past quarter: basically a holding action. Overall, the money stock measures are showing small but steady increases in growth and this is a positive note. The thing to watch here is how much of the increasing growth rate in the money stock figures is related to a rising use of currency in circulation.
Otherwise, the Fed has been true to its statements (so far) in purchasing U. S. Treasury securities to roughly offset the regular runoff from the Fed’s portfolio of Federal Agency issues and Mortgage-backed securities. Obviously, if Quantitative Easy 2 is executed, the acquisition of Treasury issues will more than offset the runoff of these other securities. Stay tuned!
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