Federal Reserve Watch: The Federal Reserve Is A Little Less Loose

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by: John M. Mason
Summary

There are small indications in the Federal Funds market that things the Fed is not as loose as it has been, but, it is not yet that significant.

The Federal Reserve still is on track to continue to raise its policy rate of interest and reduce the size of its securities portfolio without any real pressures developing.

The Federal Reserve has done a terrific job so far in its normalizing efforts and one can only hope that the effort will continue.

Two weeks ago I wrote a post with the title, “The Federal Reserve is Not Tight.”

Today, I am modifying this a little bit by saying that the Federal Reserve is a Little Tight.

Last week, we got the first bit of news that maybe the commercial banks were experiencing just a little bit of pressure.

“Joe Rennison and Robin Wigglesworh, point out in the Financial Times that ‘The US Federal Reserve’s main market interest rate has drifted back close to the top of central bank’s target range….’

“The Fed Funds rate, which the fed is attempting to keep in the middle of its target range of 2.00 percent to 2.25 percent, has risen to 2.20 percent, hitting what the central bank had hoped would be a technical ceiling.”

The spread between the effective Federal Funds rate and the upper limit of the Fed’s target range had been around 8 or 9 basis points. So, the 5 basis point gap seemed to Rennison and Wigglesworth an indication that maybe…just maybe…the slow, but steady actions of the Federal Reserve…the reductions in the Fed’s securities portfolio…might finally be putting a little pressure on bank’s liquidity positions.

This week it seems as if the pressure has risen just a little bit more.

But, by the end of the most recent banking week, October 31, 2018, the “excess reserves” in the banking system were still around $1.770 billion.

Here I am using the line item, “Reserve Balances with Federal Reserve Banks” from the Fed’s H.8 statistical release as a proxy for excess reserves in the commercial banking system. Actual excess reserves also include the cash balances banks have in their vaults, a number that is usually quite small and which doesn’t change much over time.

Note that when the Federal Reserve began to reduce the size of its securities portfolio, the amount of “excess reserves” held by commercial banks totaled around $2,180 billion. This measure of “excess reserves” maxed out on July 30, 2014 at $2,809 billion. Round three of quantitative easing ended in October of 2014.

The fact is, there is plenty of liquidity around in the commercial banking system and in the financial system itself. Those that want or need money can still find it. So, in this respect, it is hard to claim that Federal Reserve actions are really causing any restraint in the financial system…in the economy.

One hears stories all over the place that money is available, so I cannot really make a case that the Federal Reserve through its actions over the past few years has resulted in anyone…or any business…coming up short of their money needs.

Yes, interest rates are higher. The yield on the 2-year US Treasury note was around 90 basis points in early November 2016. It has climbed steadily since then, reaching the level 200 basis points above this over the past two weeks. Thursday, November 2, the yield was right around 2.90 percent.

Also, early in November 2016, the yield on the 10-year Treasury note was around 1.90 percent. Now, this the yield is just over 3.20 percent.

The interesting thing, to me, is that we have gone through this period of rising interest rates without any kind of feeling of monetary restraint or monetary dislocation.

It has only been in the past couple of weeks that there seems to have been some movement, however slight, in the Federal Funds spread.

This movement is nothing to really squirm about, because all other indications point to the fact that there is plenty of money around.

Yet, this is what we are ultimately watching for.

There is plenty of liquidity in the commercial banking system. Borrowers don’t seem to be facing any constraints on getting money. Sure, interest rates are higher, but, they were by all historical standards…low…extremely low.

We are going through a normalization process. Yes, the Fed needs to be careful if there arises any indication that what they are doing is hurting the banking system, the financial markets, the economy. The Fed does not want to be the cause of the next recession.

The economy is growing well and does not seem to be suffering from tight money. The economy is growing at the pace it is growing because of the supply-side factors at work in the economy.

Unemployment, at 3.7 percent, is at a 50 year low. And, inflation still remains low and within the Fed’s goals.

The stock markets seem to be reacting this was and that to the possibilities of a world trade war.

To me, Fed Chairman Jerome Powell seems to be doing a good job in continuing to work toward normalization of the financial markets and the banking system. His “steady-at-the-helm” approach seems to me to be just what global markets are looking for right now.

He is facing a strong…and possibly strengthening…US dollar that could create some issues later on, but the strength in the dollar seems to be coming from the problems of others, like weak economic growth in Europe, than from precisely what he is doing.

So, onward and upward, I say.

In terms of the reduction of the Fed’s securities portfolio, over the past five weeks, from September 26 through October 31, the securities portfolio declined by just over $57 billion. October was the first month that the Fed sought a reduction as large as $50 billion per month.

Since, the Fed began the reduction exercise in October 2017, it’s securities portfolio has declined by $317 billion. The target for this 13-month period was a reduction of $350.

Personally, I think that the Fed, so far, has done a tremendous job! I hope that they are able to continue in such a “calm” manner.

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.