Federal Reserve Watch: Fed Adding Bank Reserves To Support Rate Cut

Summary

• This past week the Federal Reserve cut the range for its policy rate of interest by 0.50 percent and seems to have supported this by adding excess reserves to banks.
• Because of the faith and trust that the investment community has built up in the Fed over the past ten years, maintaining this faith and trust will be very important.
• These are new times and uncertainty is extreme resulting in much market volatility, something the Fed can combat by calm, prudent management of its balance sheet.

The Federal Reserve cut its policy rate of interest by 50 basis points on Tuesday. The effective federal funds rate, which has been coming in at about 1.59 percent, dropped on Wednesday to 1.09 percent.

Along with this drop in the policy rate of interest, the Federal Reserve oversaw an increase in Reserve Balances held at Federal Reserve banks, a proxy for the excess reserves in the banking system. Reserve Balances rose by $55.0 billion during the banking week ending March 4, 2020.

The interesting thing is that the amount of repurchase agreements on the Fed’s balance sheet rose by $51.6 billion, almost equaling the amount that Reserve Balances rose. Also, it should be noted that this was the first time that the amount in the repurchase agreements account rose since the week ending January 1, 2020. Around this date, the Federal Reserve seemed to end its concern over the "repo" disruption that began in September 2019.

There were some other operational activities that took place during the banking week that ended on March 4, but over all, the rate cut went very smoothly within the banking system.

STOCK MARKET A DIFFERENT STORY

The stock market continued to be highly volatile.

As I have written elsewhere, investors had been expecting that several other central banks might move in coordination with the Fed’s rate cut, but that did not happen. As a consequence, the stock market dropped, and fell by a lot.

The early information from the markets indicates that the stock markets are in for another dismal day. The feeling seems to be, among investors, that if the central banks don’t act together, the economic and financial problems connected with the spread of the coronavirus will not be contained.

FED ACTIONS SINCE THE FIRST OF THE YEAR

Since the first of the year, the Fed has overseen an increase in Reserve Balances of more than $186.0 billion. This is quite a hefty increase over this time period.

The major change on the Fed’s balance sheet since January 1 has been the rise in the Fed’s holding of US Treasury securities. Since the start of the year, the Fed’s holdings of US Treasury securities have increased by $173.7 billion.

Some of these purchases have gone to offset the decline in the Fed’s holdings of Mortgage Backed Securities as they have matured off the Fed’s balance sheet. And, some of these purchases have gone to offset the decline in the repurchase agreements the Fed used to provide liquidity to the banking system during the time of the “repo” disturbance in the fall.

All-in-all, I believe that the Fed has been keeping things calm in the banking sector given all the disruptions that the banks have had to face, whether it be something like the “repo” problem or whether it be the large swings in items that take place over the Christmas holiday season into January.

THE NEAR FUTURE

The next “operational” event that the Fed must face is the coming tax season. Tax payments, going into “Tax and Loan” accounts at commercial banks, takes active money out of the economy. These funds generally are not drawn out of the banking system and put into the Treasury’s General Account at the Fed until the Treasury is ready to make use of them in April and beyond.

The Treasury has management the General Account differently in recent years and has followed no general pattern like it once did. But, there are a substantial movement of funds involved at tax season and these movements can impact the excess reserves that commercial banks have available. I am sure that the Fed will watch these accounts very carefully and manage them without creating any disturbances, but it is something that we need to watch during this season.

GOING FORWARD

The Federal Reserve will, obviously, do what it needs to in order to keep operational factors under control and to provide what is needed to combat the effects of the spread of the coronavirus.

I plan to keep a closer eye on Fed behavior in the coming months because we need to understand what action the Fed is actually taking as well as the things that Fed Chair Jerome Powell and other Fed officials are saying about the coronavirus crisis and other matters. This is going to be a very complex time, one clouded by a lot of uncertainty, and one facing some rather severe possible outcomes.

CONCLUSION

The investment community over the past ten years or so, has come to place a lot of faith and trust in the central bank and its leaders. The steady growth of the economy and the robustness of the stock market are the consequences of the faith and trust that has been built up.

The investment community is keeping its eye on Mr. Powell and the Fed, as I have just written because of how well they have handled things.

But, these are going to be difficult times, highly uncertain times. So, we all need to understand, as best we can, what is going on. “This time things seem different.”

Analyst’s 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.

Comments

[John M. Balder]

I disagree with your view here. In my view, the Fed has been an unmitigated disaster going back to when Alan Greenspan assumed the helm. First, he failed to understand the implications of deregulation of financial markets based on "efficient markets" that were capable of self-regulation (as he finally confessed, albeit too late to matter) in October 2008.

Then, while the Bernanke chaired the Fed during the discussions of Dodd-Frank, nothing was done to constrain how banks target the creation of money so they kept at it, boosting speculative ventures on the taxpayer's dime (with the support of QE1-3).

The Fed's thinking process has always been dominated by mainstream Ph.D. economists from Ivy League universities (I once worked at the FRBNY, though I fit neither of those categories) and, since it became "independent" of the government, it has fallen under the sway of the banking and finance industry that it is supposed to regulate.

Mainstream (neoclassical) economic models treat money and finance as though they have no impact on real economic variables. And so Robert Lucas, founder of microeconomic foundations for macroeconomics and the 1995 Nobel Prize winner, stated in 2009 that the global economic crisis fell outside the orbit of macroeconomics, having stated just six years earlier that the depression problem had been solved.

The influence of both the mainstream economics profession and the banking and financial industry over the Fed needs to be excised so that financial markets can be restructured to work for "all of the people." In the next crisis, we will need to relearn, once again, the lessons of the Great Depression, namely that unfettered financial markets (aka, financialization) inherently destabilize real economic activity.

We can either have an economy that builds good jobs, incomes and GDP, or one that is founded on financialization and speculation. And so far, policymakers and the Fed seem content to bias the economy toward the latter. This approach simply cannot work, given that asset price inflation ultimately is not sustainable.

[darturtle]

Fed's rate cut did achieved one thing - reversed inverted yield curve although it failed to pump up the market after used ~/13 of its bullets.

US cannot go negative interest rates as Japan and EU because of low saving rate thus need external financing.

Stock market is the last pillar of US economy as so many depend on it - pensions of many upon many plus many use their stocks to finance.

Giving coronavirus caused economic slow down, foreigners simply have no money to buy additional US debts. Poor relations between US and China also cause China wants to use out their US$ holding than accumulate more.

Neither conservative nor liberal will solve the coming economic depression in US.

[fujilomi]

How are the smaller banks going to make money with the rates near zero, heaven forbid negative rates? At least the bigger banks can do wealth management and credit card lending. The banking, pension and insurance systems will probably have big problems with near zero or negative rates. How are they going to pay out pensions, especially underfunded ones, or annuities without some kind of "safe" return? The FED is forcing everybody to gamble a la Japan.