Over the past week, there seemed to be more and more talk from Federal Reserve officials about a move in the Fed's target rate of interest in March. My question continues to be: Is the Federal Reserve doing things with its balance sheet to back up the talk about a possible increase.
Before the last two rate increases, in December 2015 and in December 2016, the Federal Reserve conducted a concerted effort for a month or more before they raised the rate to reduce Reserve Balances with Federal Reserve Banks, a proxy for excess reserves in the banking system. At no other time during these two years did the Fed intentionally oversee a reduction in "excess reserves." The argument for the reduction in "excess reserves" during these times is that the Federal Reserve is overseeing a reduction in bank liquidity so as to support the increase in the policy rate.
At the December 2016 meeting when the Fed last raised the Federal Funds target, Fed officials also provided some "forward guidance" to the financial markets that they might be experiencing three further increases in 2017, with each increase being 25 basis points. Fed officials had provided "forward guidance" of further rate increases each time it raised rates over the past two years, but only raised rates once each year.
So, what is the Federal Reserve doing now?
Well, in the past banking week, going from Feb. 15 through Feb. 22, "excess reserves" in the banking system declined. Now, the decline only amounted to $11.1 billion, but it was the first real decline in "excess reserves" this year. From Dec. 28, 2016, through Feb. 15, 2017, "excess reserves" increased by $311.0 billion. The decline in "excess reserves" were led by two accounts that have played a big role in Federal Reserve management of its balance sheet over the past three years or so.
First, this decline was led by a $148.2 billion decrease in reverse repurchase agreements, the primary short-run tool of the Fed. Note, that this decline was from a historic peak in the reverse repurchase agreement account of $573.8 billion, which was reached on Dec. 28, 2016. The second major move came in the General Account that the U.S. Treasury holds at the Fed. This is the account that the government writes checks from.
The decline from Dec. 28 to Feb. 15 amounted to almost $145 billion. One can note that this account reached a historic high on Nov. 30, 2016, when it totaled $422.0 billion. So, basically the Fed had drained reserves from the commercial banking system from the middle of October until just after the Fed raised its policy rate and had raised these two accounts to historic highs in order to remove the reserves.
It can be expected that these two accounts will be used when the Fed begins to prepare for another increase in its policy rate. Well, we only have one week of evidence, the past banking week, but the reverse repurchase agreement account rose by almost $65.0 billion last week, draining reserves from the banking system.
Note also that one week ago the Federal Reserve issued a call for bids on Term Deposits with Federal Reserve banks. This is another short-run tool that the Fed uses to drain reserves from the banking system. Yesterday, it was announced that $16.6 billion in bids were accepted for a one-week maturity, so that next week the Fed will show this amount on its balance sheet.
My guess is that these term deposits are aimed at helping the Fed reduce "excess reserves" while the Treasury department is writing checks before it begins to draw in tax money for the spring tax season. The General Account of the Treasury fell by $46.0 billion last week, the reason that reverse repos rose by as much as they did, that there will be another decline in the General Account this week -- and that is why the Fed issued the call for Term Deposits to help cover this decline.
Then, as happens every year, tax receipts start to flow into the Treasury and these monies will be moved to the General Account as quickly as possible to further decrease the amount of "excess reserves" in the commercial banking system. This, of course, if Fed officials are intent upon positioning the banking system for an increase in the Federal Funds rate as the March meeting of the Federal Open Market Committee meeting. And, if the move is not made in March, then the Fed is still on the path for a possible April increase.
So, my conclusion, on very little evidence, is that officials at the Federal Reserve are starting the preparation for a rate increase in March -- but if not in March, the increase will come in April. Unless, of course, the data that these officials receive make them back off from such an increase.
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