Federal Reserve Watch: Fed In New Offering Of Term Deposits

by: John M. Mason


Yesterday, the Federal Reserve took in $64 billion in term deposits signaling an effort to keep the excess reserves in the banking system from growing this tax season.

Fed officials need to keep as much control of bank liquidity as it can if it is still considering raising interest rates this spring.

Even if Fed officials decide that it will not raise interest rates this year, it still needs to control bank reserves and not reverse what it has already accomplished.

On Thursday, February 18, the Federal Reserve had an offering for floating-rate term deposits. At the end of the day, it accepted $63.9 billion of the offers.

As I have written before, in the late winter and early spring, officials at the Federal Reserve usually face a decline in US Treasury deposits, which puts reserves back into the banking system.

Federal Reserve statistics indicate (the Fed's H.4.1 release) that since the first of the year, the Treasury's General Account has declined by almost $90.0 billion through February 17, the end of the latest banking week.

Through the next five or six weeks, the Fed is likely to see a lot more money leave the Treasury account which still had $242.4 billion in it on February 17.

Last year, from December 31, 2014 through April 8, 2015, the General Account of the Treasury dropped from $223.5 billion to $44.3 billion before tax receipts started building up the account once again.

Why wouldn't Fed officials want all these funds flowing back into the banking system this year?

Well, the Fed raised its short-term policy interest rate in the middle of last December, and through its "forward guidance" indicated that it intended to raise its policy rates four times this year, beginning in March, a rise of 100 basis points.

If the Federal Reserve wants to raise interest rates, it cannot afford to have too much liquidity, too many excess reserves in the banking system. Too much liquidity would make it more difficult to increase the policy rate and sustain the increase.

Building up to the December increase in the Federal Funds target, that is from October 7, 2015 to December 16, 2015, the Federal Reserve removed almost $220.0 billion in excess reserves from the banking system.

As a consequence, the Fed raised its target range for the Federal Funds rate and has maintained an effective Federal Funds rate in the range of 0.34 percent to 0.38 percent ever since.

Given the movement in Treasury deposits after the first of the year, excess reserves in the banking system have only risen by $30.0 billion. It is easy to guess that the Fed officials do not want excess reserves to rise too much more over the next few weeks if they have any hopes for raising the policy rate according to what they set out for rate increases in 2016.

The Federal Reserve also has the policy tool of reverse repurchase agreements, which it has been using alongside term deposits. This is another way the Fed can offset movements in Treasury deposits. Since the beginning of the year, the main account the Fed has used for discretionary operations has fallen by $225.0 billion so there is room for officials to maneuver here.

Last year during the winter and spring months as Treasury deposits declined, Fed officials used these two accounts a lot. For example, on February 25, 2015, the Fed had $404.2 billion in term deposits on its books and $179.8 billion in "other" reverse repurchase agreements.

With the Fed getting back into the term deposit business, it just makes it more interesting to see how the Federal Reserve will manage its balance sheet through the 2016 tax season.

Of course, there is the possibility that Fed officials will not raise interest rates in March… or through the rest of the year.

With growing concerns that the US economy might be weakening and with the added concerns relating to the world economy, commodity prices, and military disturbances, some Fed officials have seemed to waver in recent weeks about the possible interest rate changes this year.

Market estimates of the probability of the Fed raising rates indicate that investors seem to think that there is less likelihood that rates will be raised this year than was felt to be the case earlier.

Even though Fed officials may not be as anxious to raise rates now as they once were, the Fed must continue to keep excess reserves in the banking system from rising because they cannot afford to allow the banking system to become much more liquid. This would undo what the Fed has accomplished during the fall months and would make it just that much harder for the Fed to "control" the situation in the banking industry going forward.

It will be interesting to see how the Fed conducts itself over the next six weeks or so and how it uses term deposits and reverse repurchase agreements to keep control of commercial bank excess reserves. The Fed's balance sheet is still a good source of information on what the Fed seems to be doing, regardless of how Fed officials seem to be talking.

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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.