It seemed pretty clear from the announcements coming from the September meeting of the Federal Reserve's Federal Open Market Committee that the Federal Reserve would start to reduce its balance sheet in October following a fairly rigid outline of how the Fed's portfolio of securities would be reduced.
In the past banking week, the week ending October 18, 2017, the Fed's securities portfolio actually rose by $9.7 billion - all in additions to the mortgage-backed securities portfolio.
Total assets at the Fed rose by $10.3 billion that week.
Apparently, the reduction of the balance sheet is not going to be that easy. Lots of things going on - some of which you can call operational.
But, reserve balances with Federal Reserve Banks, a proxy for excess reserves in the banking system, fell during the week by $12.6 billion.
Taking a little longer look at the statistics, the Federal Reserve's balance sheet also rose by $10.6 billion from September 6 to October 18, with most of the increase coming last week in mortgage-backed securities.
Excess reserves in the banking system fell by a total of $118.5 billion.
So, whereas the size of the Fed's balance sheet has not really changed much at all, excess reserves in the banking system have fallen.
The reason for this movement has been the large swing in the deposits of the US Treasury Department at the Federal Reserve. The General Account of the Treasury rose by $36.3 billion in the past banking week and has risen by $155.6 billion since September 6.
What is going on here? Historically, there doesn't seem to be a special seasonal swing in these deposits to account for the increase.
Over the past eight years, Federal Reserve and Treasury officials have seemed to work together and moved funds into and out of the Treasury's General Account to accommodate the Fed's monetary policy during the time of quantitative easing and especially after the time that quantitative easing had stopped.
One can see this last year as the Fed worked hard - not having the ability to use open market operations to manage its balance sheet - to reduce excess reserves in the banking system. On November 2, 2016, the Treasury's General Account reached $417.7 billion, far and away the largest level it had ever reached.
I raise this point because the Federal Reserve, working with the Treasury Department, might be increasing the general level of the General Account at this time so that it can ease out of other "tools" so as to be prepared to begin the actual reduction in the securities portfolio.
The particular "tool" I am referring to is the reverse repurchase agreement account, which the Fed used very actively during the period that it did not sell any securities outright. That is, the Fed did sell securities, but only under an agreement to repurchase them within a short period of time.
At the end of the year, the volume of reverse repurchase agreements on the Fed's balance sheet also rose to historical highs, again straining the system. Since September 6, 2017, the Federal Reserve has reduced the amount of reverse repurchase agreements on its balance sheet by $43.6 billion.
The argument here is that the Fed wants to reduce the volume of these transactions on the balance sheet so as to be able to concentrate on the level of securities it has purchased outright in its portfolio. Reducing these levels will make the actual reduction of securities bought outright on its balance easier.
And, rather than build the "reverse repo" account back up, the Federal Reserve solicited a new, 7-day, Term Deposit offering, raising $14.1 billion that went on the Fed's balance sheet on October 19.
My feeling is that these actions will make the transition to balance sheet reduction go smoother. The US Treasury Department has the funds and can move monies into and out of it's General Account to meet the needs of the Federal Reserve's actions.
That is, letting securities mature out of the portfolio and not replacing them will allow the Fed to meet its target reductions without getting things all confused with a lot of activity in the market for repurchase agreements.
Although the idea of reducing the Fed's portfolio of securities bought outright to reduce the size of the Fed's balance sheet, sounds easy, I am sure that it is much more difficult than what it appears to be on the surface. Especially when one has to consider all the operational factors that the Fed has to deal with.
We are in a period that no one has ever gone through before. Federal Reserve officials are writing the rules as they go along. Thus, the interpretation of what is going on may be confusing and somewhat difficult from time-to-time.
This is what we will be dealing with over the next few months.
Remember, the securities portfolio will be reduced by $10.0 billion in October, November, and December. The reduction in Treasury securities each month will be $6.0 billion while the reduction in mortgage-backed securities will be $4.0 billion each month.
Of course, being data driven, Federal Reserve officials can change these numbers at any time.
This is going to be interesting.
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