- The Federal Reserve continues to reduce its monthly purchases of securities... the taper.
- On the other side of the Fed's balance sheet the Fed is working in the repurchase market where it sells securities under an agreement to repurchase them. This removes reserves.
- The net effect over the past quarter and a little more is to actually withdraw reserves from the banking system.
We have been hearing so much about the Federal Reserve tapering its purchases of securities. At the most recent meeting of the Fed's Open Market Committee meeting, it decided to reduce the monthly purchases of securities to $45 billion, down from the $55 billion it had been. This news made all the press outlets.
In the four-week period from April 2 to April 30, the Federal Reserve holdings of open-market securities rose by $56 billion. Pretty close.
The interesting thing, however, is that bank reserve balances held at Federal Reserve banks actually declined by over $97 billion. This is taken from the Federal Reserve statistical release H.4.1, "Factors Affecting Reserve Balances of Depository Institutions."
The reason for this is that the Federal Reserve is actually using repurchase agreements with approved dealers in the government securities market to remove reserves from the banking system. I wrote about these transactions in my April review of Federal Reserve activity.
Actually, the line item on the Federal Reserve's balance sheet where you can find this information is titled "Other" and it comes on the liability side of the Fed's balance sheet under the line item "Reverse Repurchase Agreements." Here the Federal Reserve is selling securities under an agreement to repurchase them at a future date.
In the four-week period ending April 30, the Fed increased the amount of reverse repurchase agreements it had outstanding by more than $102 billion.
This action removes reserves from the banking system for a short-term period of time. So, in order to keep the number up or to increase the number, the Federal Reserve has to be almost continually active in this market.
This is a part of the normal operating activity of the Fed in "more normal times." The Federal Reserve began to get active in this market once again so as to be ready for the day when Federal Reserve operations can be more like they were before the financial collapse in 2007.
Other factors can also remove reserves from the banking system. Over the past four weeks, for example, reverse repurchase agreements with "Foreign Official and International Accounts" also rose by slightly more than $26 billion… and this removes reserves from the banking system.
Also, April was tax collection time. Whereas taxpayers pay taxes into the commercial banking system, the Treasury department begins to withdraw the funds from the banks and bring them into their accounts at the Federal Reserve because the government pays its bills from its Federal Reserve account. In the last four-week period, Treasury deposits with Federal Reserve banks actually rose by more than $26 billion.
So for the month of April, adding together the Fed's open market increase in reverse repurchase agreements, $102 billion, the increase to the reverse repurchase agreements with foreign official and international accounts, $26 billion, and the increase in Treasury deposits with Federal Reserve Banks, $26 billion, and you get a removal of $156 billion from the banking system.
As I mentioned above, the Federal Reserve added $56 billion in reserves to the banking system through its purchase of open market securities. The net result of these transactions: the Federal Reserve removed $100 billion from the reserves of the banking system. Other smaller transactions reduced the amount of reserve removal to only slightly more than $97 billion.
Over the past 13 weeks, the Federal Reserve only removed a little more than $11 billion in reserves from the banking system.
During this period of time, the Federal Reserve added $197 billion to its securities portfolio, an average of a little over $65 per month. However, the Fed also removed $205 billion in reserves. Taking into account other minor transactions, which reduced the amount of reserves put into the system, we end up with the $11 billion drop in reserve balances.
During this 13-week period, the Fed showed a total increase in reverse repurchase agreements of $114 billion.
Currency in circulation outside the banking system rose by $46 billion over the 13-week period. This is another drain on bank reserves because the currency has left the banking system to be used in the private sector. Treasury deposits with Federal Reserve banks rose by $29 billion during this time.
Note that one year ago on May 1, 2013, there were no reverse repurchase agreements on the balance sheet of the Federal Reserve. So, the increase of these transactions for the full year was almost $210 billion.
In summary, the Federal Reserve is tapering its purchases of open market securities. The net addition of securities to the Fed's portfolio was $986 billion, which works out to an average addition of a little more than $82 billion to the portfolio per month.
However, this is not the full story. To understand the monetary policy of the last year… more especially over the past four or five months… one must take into account the Fed's activity in the "repo" market.
We hear about the purchases that put reserves into the banking system but we hear little or nothing about the reserves the Fed is taking out of the banking system.
In other action in the banking system, we see that currency in circulation continues to increase at a historically high rate. From April 2013 to April 2014, the rate of increase was almost 8.0 percent. This indicates, to me… as I have written many times over the past four years… the weakness in the economy and the weakness of the labor market. In "not-too-good-times" people use more currency than they do in more "normal" times. This is still not an encouraging sign.
Also, demand deposits at financial institutions continue to increase at a very rapid pace, but as I have written about over the past four years, the increase in demand deposits is coming from other short-term assets that are not paying very much interest. It doesn't pay people to keep their funds in an interest-bearing asset because of the trouble it takes to move their assets around… they might as well keep the money in a demand deposit.
Small deposits at financial institutions declined by almost 13.0 percent, April-over-April, retail money market funds declined by 0.3 percent, year-over-year, and institutional money markets dropped by 0.8 percent year-over-year.
In essence, people are moving their funds into transaction accounts from other short-term assets that are paying next to no interest. This, too, is not a good sign of economic health. When the economy is improving, demand deposits are increasing but that is because banks are making loans and this is causing deposits to increase. That is not happening now, to any degree.
So the Federal Reserve continues to taper with its right hand, but is withdrawing funds from the banks with its left hand. The lending at financial institutions is not very robust and people continue to move their funds into assets where they can readily spend them. This is not a picture of a very robust economy.