Last month I presented Part 13 of my exit watch of the Federal Reserve. In the summer of 2009, the Fed stated that it was going to remove reserves from the banking system to reverse the massive injection of reserves that took place in late 2008 and early 2009.
The Federal Reserve really did not “exit” over this 13 month period. In fact, bank reserves and excess reserves actually increased during that time period. From my post on
August 10, 2010 (see http://seekingalpha.com/article/219717-federal-reserve-exit-watch-part-13):
“Here we are 13 months into the “exit watch” and there has been ‘no exit’ of reserves from the banking system. In fact, Reserve Bank credit is now $331 billion GREATER than it was one year ago; it has grown over the past 365 days by 16.7%, as of August 4, 2010.”
Over the past month, the Federal Reserve has backed off from this policy of removing reserves from the banking system because of the concern over the fragile condition of the smaller banks in the United States and the failure of unemployment to fall. Chairman Bernanke has spoken about the need for the Federal Reserve System to focus on the economy while “the FOMC will do all that it can to ensure continuation of the economic recovery.” This is from the speech he gave at Jackson Hole, Wyoming on August 26 (see my post http://seekingalpha.com/article/222704-bernanke-in-the-hole).
Thus, the “Federal Reserve Exit Watch” becomes the “Federal Reserve Non-Exit Watch.”
There are two areas to focus on in this “Non-Exit Watch.” The first relates to all of the “innovations” the Federal Reserve created to bailout various financial institutions (like Bear Stearns and AIG that “blew up” the Fed’s balance sheet) and to engage in “liquidity swaps” with other central banks throughout the world. The plan is for these accounts to decline incrementally as assets are worked off or that the need for central bank liquidity swaps declines.
Over the last four weeks ending September 1, 2010, these Federal Reserve accounts that were created during the financial crisis have declined by $16.4 billion. Central bank liquidity swaps have fallen to almost zero and the other “crisis” portfolios the Fed maintains continue to run off. Still the Fed’s balance sheet maintains more than $150 billion in assets that are connected with the financial upheaval.
Over the past 13-week period these accounts have dropped by a little more than $22 billion. These accounts should continue to decline in the future, but the pace of decline will not be large.
The second area relates to the securities portfolio of the Fed. As a part of its support of financial markets, especially the mortgage market, the Federal Reserve bought substantial amounts of mortgage-backed securities and federal agency securities. A part of the “exit” strategy of the Fed was to let these securities “run off” as they matured thereby helping to reduce the excess reserves held by the commercial banking system.
It appears as if the “non-exit” plan is to replace the maturing mortgage-backed securities and federal agency securities with outright purchases of United States Treasury issues. In this way the Fed will keep funds in the banking system so as to encourage bank lending and economic growth but will reduce the role that it has played in specific sub-sectors of the financial markets.
It appears as if the Fed began this program within the past four-week period. Between August 4 and September 1, the volume of mortgage-backed securities at the Fed dropped off by $14.5 billion and the amount of federal agencies on the books of the Fed fell by $2.9 billion.
United States Treasury securities “held outright” by the Federal Reserve rose by $9.3 billion so that the volume of all securities held by the Fed dropped by only $8.1 billion. Note that this action was concentrated in the last four-week period for this behavior was not observed in the nine earlier weeks of the last 13-week period.
Overall, reserve balances with Federal Reserve banks fell by $27.2 billion over the last four-week period. Part of the drain from the Fed was the seasonal rise in both currency in circulation and bank needs for additional vault cash during the summer to handle the vacation pickup in the demand for currency. These movements result in an increase in factors absorbing reserve funds which reduces reserve balances at Federal Reserve banks. As a consequence, the excess reserves in the banking system remained relatively constant. There are always these “operational” factors occurring that the Fed must take account of in order to help the banking system function as smoothly as possible.
Given what Bernanke and others at the Federal Reserve have said, we must keep our eyes on what the Fed does with its securities portfolio. The Fed does not seem to want to maintain its mortgage-backed securities portfolio or its federal agency portfolio at the levels achieved earlier this year. It appears that the Fed will allow the volume of these portfolios to decline naturally as they mature and run off. The thing to watch is whether or not the Fed replaces this run-off with the acquisition of United States Treasury issues.
The good thing I see about this is that in “normal” times the Federal Reserve has primarily conducted its monetary policy using the Treasury market, either through outright purchases or through the repurchase market. Thus, to reduce the amount of mortgage-backed securities and federal agency securities in its over-all portfolio and to increase the proportion of Treasury securities is, to me, a good thing.
However, even though the Federal Reserve, over time, is going to have to withdraw the excessive amount of reserves it has pumped into the banking system, this is not going to happen in the near term. There was a lot of “bad” economic news that came out in August. This “bad” news had a very negative impact on the polling statistics of the President and created a very dark picture for Democratic politicians looking forward to the November elections. Within such an environment, the Federal Reserve and its officials must appear to be working to accelerate the economic recovery and help put more people back to work.
Thus, the Fed is not likely to allow reserves to decline by much in the banking system, although I doubt that they really want to increase reserves much throughout the fall. For the time being, it looks as if the best bet is that the Fed will let the runoff continue in mortgage-backed and federal agency securities, replacing them with purchases of Treasury securities. This will take place while the Fed allows the “crisis” assets to continue to decline as they are resolved. The only deviation from this picture would occur if the economy or the banking system took a turn for the worse.
Showing posts with label federal reserve exit watch. Show all posts
Showing posts with label federal reserve exit watch. Show all posts
Monday, September 6, 2010
Monday, August 9, 2010
Federal Reserve Exit Watch: Part 13
In the summer of 2009, a great deal of concern was expressed about the Federal Reserve and the excessive amounts of Reserve Bank credit that had been pumped into the banking system. The Federal Reserve stated that it had an “exit” plan to withdraw these reserves from the banking system so as not to create an inflationary or hyper-inflationary environment once the economic recovery began to pick up speed.
Here we are 13 months into the “exit watch” and there has been “no exit” of reserves from the banking system. In fact, Reserve Bank credit is now $331 billion GREATER than it was one year ago; it has grown over the past 365 days by 16.7%, as of August 4, 2010.
The stated reason for this “no exit” performance: the economy has remained stagnant and as long as the economy stays very weak the Federal Reserve will keep its low target interest rates which means that the target Federal Funds rate will remain close to zero for an “extended period”.
As I have reported in my blog posts, my belief is that the Federal Reserve is excessively concerned about the solvency difficulties being experienced by the small banks in this county, a concern that I have recently summarized in my post of August 2, titled “No Banks, No Recovery,” http://seekingalpha.com/article/218027-no-banks-no-recovery. There are many small banks experiencing extreme problems and the Federal Reserve is not going to begin withdrawing reserves from the banking system until there is some indication that this solvency problem is over.
Commercial bank Reserve Balances with Federal Reserve Banks has risen by $334 billion over the past year, an increase of 46.6% since August 5, 2009. Note that Excess Reserves at depository institutions rose from a monthly average of $750 billion in June 2009 to $1,035 billion in June 2010, an increase of 38%.
This is a strange “exit.”
And, as the Federal Reserve has pumped these additional reserves into the banking system, the total assets of the commercial banks in the United States fell by 1.7% from almost $12.0 trillion to about $11.8 trillion from June 2009 through June 2010. Loans and leases at these commercial banks declined by 2.6%. Banks got out of a substantial amount of business loans during this time period, as commercial and industrial loans fell by 16.7%, June-over-June, and commercial real estate loans declined by 7.8%, year-over-year.
The reserves the Fed is pumping into the banking system are not going into “pumping up” the economy. The reserves the Fed is pumping into the banking system are just going into excess reserves!
Looking at a shorter period of time, over the past 13 weeks, the last quarter, Reserve balances with Federal Reserve banks rose by $8.0 billion. The primary swings in the Fed’s balance sheet over this time period were operational in nature. There was a $26 billion decrease in the General Account of the U. S. Treasury, a seasonal increase in currency in circulation of about $9 billion and a $7 billion rise in Foreign Reverse Repos. The offsetting transactions of the Fed to neutralize these changes was an increase in Securities Held Outright by the Fed of about $12 billion, the primary increase coming in the Fed’s purchase of Mortgage-backed securities.
In the past 4 weeks, the U. S. Treasury balance reversed itself, increasing by almost $28 billion and there were modest declines in currency in circulation and Foreign Reverse Repos. The Fed offset a portion of these by letting it holdings of Federal Agencies decline by a little more than $5 billion. The net effect of these operating transactions was a $19 billion decline in Reserve balances held at Federal Reserve banks.
Thus, over the past 4 weeks and over the past 13 weeks, Reserve Bank Credit barely changed. Both periods were dominated by operating transactions within the banking system offset by Federal Reserve balancing transactions.
As a consequence, excess reserves in the banking system stayed relatively constant over the last quarter of the year.
Loans and leases at commercial banks continued to decline over the last 4-week and 13 week periods as did commercial and industrial loans and commercial real estate loans.
In summary, the Exit Watch in the thirteenth month of its existence can report little or no action on the exit front over the past month or the past three months. “Exit” is still on hold until either the general condition of the small banks improves or the economic recovery really becomes an economic recovery…or both.
Here we are 13 months into the “exit watch” and there has been “no exit” of reserves from the banking system. In fact, Reserve Bank credit is now $331 billion GREATER than it was one year ago; it has grown over the past 365 days by 16.7%, as of August 4, 2010.
The stated reason for this “no exit” performance: the economy has remained stagnant and as long as the economy stays very weak the Federal Reserve will keep its low target interest rates which means that the target Federal Funds rate will remain close to zero for an “extended period”.
As I have reported in my blog posts, my belief is that the Federal Reserve is excessively concerned about the solvency difficulties being experienced by the small banks in this county, a concern that I have recently summarized in my post of August 2, titled “No Banks, No Recovery,” http://seekingalpha.com/article/218027-no-banks-no-recovery. There are many small banks experiencing extreme problems and the Federal Reserve is not going to begin withdrawing reserves from the banking system until there is some indication that this solvency problem is over.
Commercial bank Reserve Balances with Federal Reserve Banks has risen by $334 billion over the past year, an increase of 46.6% since August 5, 2009. Note that Excess Reserves at depository institutions rose from a monthly average of $750 billion in June 2009 to $1,035 billion in June 2010, an increase of 38%.
This is a strange “exit.”
And, as the Federal Reserve has pumped these additional reserves into the banking system, the total assets of the commercial banks in the United States fell by 1.7% from almost $12.0 trillion to about $11.8 trillion from June 2009 through June 2010. Loans and leases at these commercial banks declined by 2.6%. Banks got out of a substantial amount of business loans during this time period, as commercial and industrial loans fell by 16.7%, June-over-June, and commercial real estate loans declined by 7.8%, year-over-year.
The reserves the Fed is pumping into the banking system are not going into “pumping up” the economy. The reserves the Fed is pumping into the banking system are just going into excess reserves!
Looking at a shorter period of time, over the past 13 weeks, the last quarter, Reserve balances with Federal Reserve banks rose by $8.0 billion. The primary swings in the Fed’s balance sheet over this time period were operational in nature. There was a $26 billion decrease in the General Account of the U. S. Treasury, a seasonal increase in currency in circulation of about $9 billion and a $7 billion rise in Foreign Reverse Repos. The offsetting transactions of the Fed to neutralize these changes was an increase in Securities Held Outright by the Fed of about $12 billion, the primary increase coming in the Fed’s purchase of Mortgage-backed securities.
In the past 4 weeks, the U. S. Treasury balance reversed itself, increasing by almost $28 billion and there were modest declines in currency in circulation and Foreign Reverse Repos. The Fed offset a portion of these by letting it holdings of Federal Agencies decline by a little more than $5 billion. The net effect of these operating transactions was a $19 billion decline in Reserve balances held at Federal Reserve banks.
Thus, over the past 4 weeks and over the past 13 weeks, Reserve Bank Credit barely changed. Both periods were dominated by operating transactions within the banking system offset by Federal Reserve balancing transactions.
As a consequence, excess reserves in the banking system stayed relatively constant over the last quarter of the year.
Loans and leases at commercial banks continued to decline over the last 4-week and 13 week periods as did commercial and industrial loans and commercial real estate loans.
In summary, the Exit Watch in the thirteenth month of its existence can report little or no action on the exit front over the past month or the past three months. “Exit” is still on hold until either the general condition of the small banks improves or the economic recovery really becomes an economic recovery…or both.
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