Federal Reserve Report: No Need for QE3

I keep reading that some people want to have the Federal Reserve begin a new round of quantitative easing…QE3.

I see nothing in the financial figures that calls for more quantitative easing.

For one, there seems to be no pressure on interest rates.  Looking over the last 13-week period the yield on the 10-year US Treasury (constant maturity) has remained relatively constant.  The weekly average for the week of November 4, 2011 was 2.07 percent: for the week of January 27, 2012 the weekly average was 2.01.  And, the market yield on 10-year Treasuries has been below 2.00 percent all of this week.

The European sovereign debt situation has certainly contributed to this weakness in yields.  Hence, there does not seem to be any demand pressure on interest rates at this time.

Economic growth continues to be modest and consequently is not adding any demand pressure on rates.

The commercial banking system is quiet and even though bank closures average around 2 per week adjustments are being made smoothly and with little or no disruption to the industry. 

Excess reserves in the banking system have fluctuated around $1.5 trillion over the past three months indicating little or no pressure on the financial system on the loan demand front.  This, too, is consistent with the modest economic growth.

Overt Federal Reserve actions have been absent over the past 13-week period indicating that the Fed is allowing operating factors to work themselves out without undue disturbance to the monetary system. 

The big change on the Fed’s balance sheet has to do with the European debt crisis.  Central bank liquidity swaps have risen by a little more than $100 billion since November 2, 2011 as the Fed moved to assist central banks in Europe.  It appears as if part of this increase went to take pressure off the market for Reverse Repurchase agreements with foreign official and international accounts.  The account recording this activity fell by about $41.0 billion over the same time period.

This has resulted in a net increase of about $53 billion in Reserve Balances at Federal Reserve banks but this has had little or no immediate impact on the United States banking system.

Actually, Reserve Balances at Federal Reserve banks declined by $7.0 billion over the past four-week period.  The increase in central bank liquidity swaps was just about totally matched by the decline in reverse repos with foreign official and international accounts as other factors removed reserves.

In terms of Federal Reserve open market operations, the securities account at the Fed actually declined in both the latest 4-week and 13-week periods.  Securities bought outright dropped by a little more than $11.0 billion since November 2 and by a little more than $5.0 billion since January 4. 

Over the past 13 weeks, about $20.0 billion in federal agency issues and mortgage-backed securities ran off in the portfolio.  The Fed only replaced this runoff by a little more than $8.0 billion.  In the latest 4-week period, the runoff in securities was across the board.

The conclusion I draw from the latest Federal Reserve statistics is that the Fed has had a relatively peaceful 13 weeks.  Money continues to flow into the United States Treasury markets seeking a “safe haven” from what is going on in Europe.  This, along with the mediocre economic growth in the country, has taken pressure off the Fed to buy more securities in order to keep interest rates low.  The fact that the securities portfolio at the Fed has declined over the past 13 weeks indicates that the Federal Reserve is letting market forces keep interest rates low and, for a change, is staying out of the market. 

If these conditions continue, I see no justification for any talk about another round of quantitative easing.

The money stock numbers are continuing to maintain excessive growth rates.  The year-over-year rate of growth of the M1 measure of the money stock for the week ending January 24, 2012 is 18.7 percent; the M2 measure of the money stock is growing at 9.7 percent.

Over the past three years I have been arguing that the reason that these money stock growth rates are so high, given the fact that commercial banks did not seem to be lending and that the reserves being pumped into the system by the Fed were going into excess reserves, is that the dire economic conditions have caused individuals and businesses to move their funds from interest bearing assets to transaction assets like currency and demand deposits.  The very low interest rates on the interest bearing assets also contributed to this movement.

Now, however, it seems as this re-arrangement of liquid asset holdings has slowed down.  This is something I think we want to keep our eyes on, for it could be that households and businesses have done all they can do to “be liquid” in bad times.  Thus, we will either see a slow-down in money growth measures (the rates have dropped since the first of November from a 20.0 percent year-over-year rate of growth for M1 and a 10.0 percent rate for M2) or we will see spending starting to increase as these transactions accounts are being used to actually buy things.  It will be interesting to see what happens here.

If people and businesses do speed up their expenditures, this fact would be another reason why another round of quantitative easing would not be necessary.  The Fed would have done enough.   

Growth Accelerates in Money Stock Measures

Let’s start with another interesting fact from the commercial banking industry: 92 percent of the banks in the country hold 10 percent of the total banking assets in the country as of March 31, 2011 (FDIC banking statistics) but this total ($1,181.0 billion in total assets) is only 60% of the cash assets in the whole banking system on August 3, 2011 (Federal Reserve H.8 release) and only72 percent of the Reserves at Federal Reserve Banks on August 3, 2011 (Federal Reserve H.4.1 release) and only 74 percent of the Excess Reserves in the banking system for the two-week average ending August 10, 2011 (Federal Reserve H.3 release).

In other words, the total assets residing in 92 percent of the commercial banks in the United States is substantially less than the amount of excess reserves pumped into the banking system by the Federal Reserve since August 2008. (For more comparisons see my post of August 15, 2011, http://seekingalpha.com/article/287494-foreign-related-financial-institutions-continue-to-suck-up-u-s-excess-reserves.)   

Now let’s look at the recent behavior of the money stock measures.  Both measures of the money stock (M1 and M2) experienced accelerating rates of growth over the past year, with the acceleration increasing over the past several months. 

The M1 money stock measure was growing at a year-over-year rate of 16.1 percent in July, up from 10.0 percent in January 2011 and 5.4 percent in the summer of 2010.  The M2 money stock measure is growing year-over-year in July 2011 at 8.3 percent, up from 4.3 percent in January and around 2.5 percent in the summer of 2010.

Is this a sign that the Fed’s quantitative easing (QE2) is working or is it a result of something else going on in the economy? 

Generally when the money stock measures are growing, commercial bank lending is fueling the growth.  Banks loans are put into demand deposits to spend and this spending spurs on the economy.

It is hard to find much loan growth in the commercial banking sector at this time. (See my post http://seekingalpha.com/article/287494-foreign-related-financial-institutions-continue-to-suck-up-u-s-excess-reserves.)  Thus, it is hard to conclude that the increase in the growth rates of the two money stock measures results from the Fed’s injection of reserves into the banking system.

The path that I have been following over the past two years is that the extremely weak condition of the economy and the extremely low interest rates are causing a “dis-intermediation” of sorts as people move their funds from interest bearing assets into transaction-related accounts to either be able to pay for necessities because cash flows are low due to unemployment or other situations of financial distress, or, because interest rates are so low on savings or money market accounts that it is doesn’t pay for wealth-holders to keep money in these latter types of accounts.

What we see is that demand deposit accounts at commercial banks have exploded.  In July, the year-over-year rate of growth of this component of the money stock has increased dramatically to over 37.0 percent, up from just 21.0 percent in March of this year.  Other checkable deposits at depository institutions have also increased by not at such a rapid pace. 

Along with this we still see substantial drops in “savings” categories.  Small-denomination time deposits have fallen at a 20.0 percent rate, year-over-year.  Retail money funds have dropped by over 6.0 percent, year-over-year, and institutional money funds are still declining at more than a 4.0 percent, year-over-year rate. 

Funds are still moving from (formerly) interest earning accounts to transaction-type accounts. 

One further indication that some of this is due to “economic stress” is that the amount of currency in circulation is increasing.  In July, currency in circulation was more than 9.0 percent higher than it was a year ago.  This is up from around 7.0 percent earlier this year.

My basic point here is that although the growth rate of both money stock measures are increasing, that this information does not indicate that Federal Reserve monetary policy is working or that economic growth will benefit from this expansion.

The money stock measures are experiencing increasing rates of growth due to the fact that the economy is extremely weak and that interest rates are extremely low.  People…and businesses…are just re-allocating their funds so that their money is easier to get for spending purposes (distress) or that other assets are earning so little it doesn’t pay to keep funds in those accounts…or both.

In my view, there is no cause for hope for an economic recovery in the current monetary statistics.