Federal Reserve Balance Sheet Moves Point To No Interest Rate Increase

by: John M. Mason


In the fall of 2015, the Federal Reserve reduced excess reserves in the banking system to prepare for its December increase in its target rate of interest.

Up until last week and the not-so-good news from the labor market, it appeared as if the Fed was preparing for another rate increase.

Excess reserves in the banking system increased by almost $35 billion last week, seemingly confirming market expectations that no rate increase is coming soon.

Ever since the not-very-good news from the labor market was released last Friday, the belief has been that the Federal Reserve would back off from raising its policy interest rate in June.

The latest Federal Reserve statistics, in my mind, confirm this belief.

Last week, reserve balances with Federal Reserve banks, a proxy for excess reserves, rose by $47.8 billion.

Over the past five weeks, from May 4 through June 8, reserve balances have increased by $65.4 billion.

When the Federal Reserve raised its policy rate of interest in December, it had worked since the middle of October to reduce excess reserves so as to support the rise in rates.

As of two weeks ago, it appeared as if the Fed was doing what it did last fall, preparing the banks for another rise in the policy rate.

Even now, with the increases in excess reserves over the past weeks, these reserve balances are down from the middle of March, the time where the data could be interpreted as representing a move on the part of the Fed to prepare banks for the increase in rates.

Thus, it looks as if officials at the Fed have resigned themselves to the fact that there will be no movement in the policy rate in the next month or two.

As described in my earlier posts, the Fed had used the seasonal flow of deposits into government accounts due to tax payments to reduce reserves in the banking system.

Historically, when taxes are paid, they go into government accounts at commercial banks. These funds are usually not moved into the government's General Account at the Fed until the government actually starts writing checks against these monies.

The reason it has usually been done this way is that it minimizes movements in bank reserve accounts so that they can function without disturbances in their reserve positions.

Given that the Fed is not using open market operations these days to alter the reserve positions of commercial banks, the Fed is using other tools, like the government's General Account, term deposits and reverse repurchase agreements.

Over the past five weeks, the government's balance in its General Account at the Fed fell by almost $100.0 billion. In the last week alone, the account dropped by almost $35.0 billion.

Accompanying this drop last week was a decline of almost $20.0 billion in the reverse repurchase agreement account that the Fed has used for much of its withdrawal activity. A decline in this account also releases reserves into the banking system.

In my mind, the movement in the Fed's balance sheet this past week confirms the fact that we will not see any increase in the Federal Funds target rate in the near future. Events could change this because we must remember that the Fed is "data driven." However, I don't see this happening soon.

The effective Federal Funds rate remains at 0.37 percent.

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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.