Federal Reserve Watch: No One Said It Was Going To Be Easy

by: John M. Mason

Summary

Since the end of September, the Federal Reserve has reduced the size of its securities portfolio, but not by much.

To its announced reductions, the Fed has also has to deal with seasonal and other operational factors that impact the banking system and the Fed cannot avoid these factors.

For example, dominating the last month or two has been a reduction of $113 billion of Treasury deposits at the Fed and a $24 billion outflow of currency in circulation.

As expected, the Federal Reserve raised its target range for the Federal Funds rate by 25 basis points this week. The Fed’s securities portfolio rose by $12.9 billion this week according to the Federal Reserve’s H.4.1 statistical release.

Wasn’t the securities portfolio supposed to be declining? The Fed’s securities portfolio has declined since September 27, 2017, but only by $1.4 billion.

No one said that balance sheet reduction was going to be easy, although the schedule the Fed put out made it seem as if the reduction would take place like clockwork.

The item change that dominated the Fed’s balance sheet this week was the US Treasury Department’s General Account at the Federal Reserve.

This account fell by $57.4 billion as the US Treasury Department wrote checks on the General Account, which were then deposited in the commercial banking system.

Apparently, Federal Reserve officials felt that put too much money back into the banking system when a rate increase was about to take place, so it offset this movement of funds by entering into $68.4 billion of repurchase agreements.

Reverse repurchase agreements represent a short-term sale of securities under an agreement to buy the securities back after a very short period of time. These transactions usually take place when it is felt that the need to remove reserves from the banking system is temporary.

The expectation here is that the Treasury Department will begin to bring funds back into the General Account after the first of the year. This is a seasonal movement, one that happens every year.

Why didn’t the Federal Reserve just reduce the amount of securities that it held outfight? Well, this flow of funds was expected to be temporary and therefore should be handled with temporary actions. This allows the management of the securities held outright to continue along the path that had been planned for.

In fact, the Fed has used some of the reduction in the securities held outright to offset some of the outflow of Treasury funds.

Actually, since November 1, 2017, the Treasury’s General Account declined by $113.1 billion. Less than half of this decline was offset by the use of repurchase agreements.

These changes represent some of the difficulties that Federal Reserve officials face in pulling off the balance sheet reductions that they have announced.

Another such seasonal occurrence is the movement of coin and currency into the hands of the public during the holiday season from early November through the first of the new year.

Since September 27, 2017, up to December 13, 2017, almost $24.0 billion of coin and currency has flowed from the banking system to the public reducing bank reserves. Overall Federal Reserve actions must also take this drainage into account in managing the banking system.

Things become a little less confusing after January 1 and this should ease the Fed’s effort to carry out its balance sheet reduction plans. After the first of the year, coin and currency flows back into the banks, increasing commercial bank reserves. The only major event coming up in the first part of the year is the tax date in April. But, tax payments flow into the Treasury’s Tax and Loan accounts at commercial banks, not into the General Account at the Fed.

So, unless there are major disruptions to financial markets, the Fed should have three months or so to carry out its plans to reduce the amount of securities its holds outright on its balance sheet.

Up through December 13, the US Treasury securities on the Fed’s balance sheet have declined by $11.1 billion from September 27. US Agency securities have declined by $2.4 billion. Mortgage-backed securities have risen by $12.0 billion, a result of timing issues. Thus the overall decline in the whole securities portfolio has been $1.4 billion.

Stay tuned, we still have a little more than two weeks to get us through the end-of-year holiday season.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

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