The Fed Acts!

Federal actions on QE2 have been relatively benign up to this week. (See my Monday post: http://seekingalpha.com/article/240375-federal-reserve-qe2-watch-part-1.)

Things were different this week as the United States Treasury issued a lot of bonds this week and longer terms interest rates rose to levels not seen since the middle of June 2010. The 10-year Treasury security got up to almost 3.30 percent on Wednesday, up by about 45 basis points over the past two weeks or so.

The Federal Reserve added over $32 billion in Treasury notes and bonds to its portfolio from Wednesday December 1 to Wednesday December 8. This move was not to replace mortgage backed securities as was the case over the past few weeks.

Also, this increase was not to replace reserves lost through operating transactions. Quite the contrary, deposits with Federal Reserve Banks other than reserve balances, which includes the General Account of the United States Treasury fell by almost $8 billion which also added reserves to the banking system.

All-in-all, over $50 billion was added to Reserve Balances with Federal Reserve Banks over the past week. Most, if not all of this will show up in Excess Reserves at commercial banks.

In August 2008, before the Fed started pumping reserves into the banking system, total reserves at all commercial banks totaled $46.4 billion!

The initial interpretation of this is that the Fed acted to keep long term interest rates from rising further. The ten-year bond rate was down slightly today, closing around 3.23 percent at 4:00 PM, New York time. This is what QE2 is supposedly all about!