Federal Reserve QE2 Watch: Part 3.2

The Federal Reserve’s liquidity machine continues “full speed ahead”!

In the banking week ending February 16, 2011, the Fed injected almost $31 billion in new reserve balances into the banking system.

Over the past two banking weeks the Fed has pushed almost $140 billion in new reserve balances into the banking system.

Since the end of 2010 (the banking week ending December 29, 2010) the Fed has increased reserve balances with Federal Reserve Banks by almost $200 billion!

Thus, reserve balances at the Fed, a proxy for excess reserves in the banking system, have increased by a whopping 20% over the past six weeks.

The Federal Reserve is doing to the banking system what it said it was going to do.

In the fall of 2008 and winter of 2009, Chairman Ben Bernanke tossed as much Spaghetti against the wall as he could toss to see what would stick.

It appears that we are not necessarily in the middle of Quantitative Easing 2 (QE2), but are instead in the middle of Spaghetti Toss 2 (ST2)!

The Fed continued to buy more government securities last week, increasing its portfolio by about $23 billion. This supplied reserve funds to the banking system.

The big increase in bank reserves came, once again, in the U. S. Treasury Supplementary Financing Account. (For more on this account and its use see my post http://seekingalpha.com/article/199444-the-fed-s-new-exit-strategy) This account declined by $25 billion for the second week in a row. When this account increases it “absorbs” funds from the banking system. Therefore, when it declines it releases funds into the banking system.

Thus, over the past two weeks when reserve balances rose by almost $140 billion, $50 billion of the increase came from the Fed adding more Government securities to its portfolio and $50 billion came from the Treasury releasing funds to the banking system from its supplementary financing account.

Since December 29 when reserve balances rose by almost $200 billion the Fed bought almost $140 billion in government securities (about $34 billion going to offset maturing mortgage-backed securities), the Treasury reduced its Supplementary Financing Account by $50 billion AND reduced its General Account by almost $35 billion.

This last movement was the usual seasonal swing from the build up in tax revenues toward the end of a calendar year. It still puts reserves into the banking system.

To put things into perspective: Remember back in August 2008, the total reserves in the banking system were $46 billion and excess reserves were less than $2 billion.

Now, within the span of six weeks the Federal Reserve injected into the banking system four times the amount of total reserves that was held by the whole banking system at that time. The wave that is coming looks like it is a part of a Tsunami!