The Federal Reserve continues to stick to its word by reducing the amount of securities it purchases outright.
Last week, the Fed only added $16.4 billion in securities to its portfolio, bringing the total it has acquired over the month of February to $82.6 billion for the month.
Note that these figures are taken from the data the Federal Reserve provides us in its statistical release H.4.1, “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks.”
Furthermore, the numbers are taken from the Wednesday date, which is the ending day of the Fed’s banking week. The other figures are averages of daily figures and these don’t give us specific numbers for the week to compare with other specific numbers.
So from the end of the banking week January 26, 2022, to the end of the banking week February 23, 2022, the Federal Reserve added $82.6 billion of securities to its portfolio.
From December 29, 2021, to January 26, 2022, the Fed added $109.3 billion to its portfolio. From December 1, 2021 to December 29, 2021, the Fed added $104.7 billion.
Remember, the Fed had been adding roughly $120.0 billion to its portfolio every month since April 2020.
So, it appears as if the Fed has lived up to its promise of tapering the amount of securities it purchases every month.
Federal Funds Rate
The Federal Reserve has also continued to maintain its policy rate of interest at 0.08 percent.
The Fed has kept the effective Federal Funds rate constant at this level since September 1, 2021.
To maintain this rate at 0.08 percent given all the liquidity the Fed was pumping into the economy with its monthly purchases the Fed has had to turn around and sell a lot of securities under an agreement to repurchase them after a very short period of time.
In the last banking week, the Fed increased the amount of reverse repurchase agreements it carried on its balance sheet by $91.6 billion.
Some of this increase went to offset a $34.5 billion decline in the deposit balances of the U.S. Treasury Department from its General Account at the Fed. When the balances in the General Account decline, the reserves in the banking system go up. So, part of the $91.6 billion increase in “repos” went to take out the money going into the commercial banking system from the actions of the Treasury Department.
But, even though the Fed was tapering the amount of securities it was purchasing in the open market, it still was putting enough reserves into the banking system that the “repo” market needed to take reserves out of the banking system in order to sustain the Federal Funds rate at 0.08 percent.
And, this has been the general story since September 1, 2021, when the Fed began its efforts to keep the effective Federal funds rate at 0.08 percent.
The Fed was living up to its promise to purchase, outright, $120.0 billion in securities every month, but all this liquidity entering the market would have resulted in the effective Federal Funds rate falling unless the Fed did something else to offset these injections.
In fact, since September 1, 2021, the amount of reverse repurchase agreements on the Fed’s balance sheet has increased by $616.8 billion. This reduced bank reserve balances. That is it helped reduce the amount of excess reserves in the banking system by $460.4 billion since that September date.
It should also be noted that during this time period of time, the U.S. Treasury Department increased its deposits in its General Account at the Fed by almost $380.0 billion. This also reduced the excess reserves of the banking system, helping keep the Federal Funds rate up at 0.08 percent.
The Future
The Federal Reserve continues to signal that the tapering of securities’ purchases will end in March.
And, it continues to signal that it will increase its policy rate of interest after it stops buying securities. That is, the Fed intends to raise the range set for its policy rate of interest by 25 basis points.
That would take the range for the Federal Funds rates to 0.25 percent to 0.50 percent.
Furthermore, Federal Reserve officials continue to talk about more increases coming this year. The talk is about anywhere from two to five more increases this year.
The concern is over how the Fed will accomplish these increases.
Since September 1, 2021, the Fed has had to withdraw funds from the banking system through the repo market to just keep the Federal Funds rate at 0.08 percent.
The Fed has been able to keep the rate at 0.08 percent by selling securities in the “repo” market. What is it going to do when tapering ends?
Fed officials have said that they will reduce the Fed’s portfolio of securities by letting securities “mature off” the balance sheet.
But will this be enough?
And, how is it going to handle the “repo” effort? The Fed has almost $2.0 trillion of reverse repurchase agreements on its balance sheet. These “sales” are very short-term. Is the Fed going to maintain this balance?
Letting “repos” run off just adds to the excess reserves of the banking system, putting downward pressure on interest rates.
Will the Fed have to actually begin to sell securities from its balance sheet?
Fed officials seem to want to avoid this.
And, What About Markets?
Then, there still is the concern about creating a drop in the stock market.
The stock market has been in decline since trading opened in January. The first reason for this fall was connected to the rise in inflation and the need for the Federal Reserve to “tighten up” on monetary policy.
Added to this were the evolving events in Ukraine. Now, that invasion is happening and the stock market has dropped further.
How is the Fed going to handle raising its policy rate of interest and shrinking its balance sheet given that the stock market may be declining and declining by a substantial amount?
Uncertainty rules. And, we don’t even know what some of the possible outcomes might be.