Federal Reserve Watch: Securities Portfolio Down $233 Billion

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The Federal Reserve continued to see the size of its securities portfolio decline.

As of October 29, 2022, the securities portfolio of the Federal Reserve has declined by $232.5 billion from March 16, 2022, the time the Fed began its current program of quantitative tightening.

Reserve balances with Federal Reserve banks have declined by $785.3 billion since March 16.

Most of the decline in reserve balances has come from the rise in reverse repurchase agreements. Reverse repurchase agreements have declined by $624.8 billion since March 16.

Reverse repurchase agreements are transactions where the Federal Reserve sells securities under an agreement to buy the securities back at the end of the agreement time, which can be overnight, one-day, two-days, or more.

I write that reverse repurchase agreements have declined by $624.8 billion since March 16, 2022.

This number is obtained by taking the end-of-the-day balance for the line item reverse repurchase agreements on the Fed’s balance sheet, found on the H.4.1 release of the Federal Reserve titled “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks.” The first item on the release is titled “Factors Affecting Reserve Balances of Depository Institutions.” This release presents the balance sheet of the Federal Reserve.

At the close of business on March 16, 2022, the Federal Reserve reported that the end-of-day balance for Reverse Repurchase Agreements on the Fed’s balance sheet was $1,864.6 billion.

At the close of business on October 29, 2022, the balance reported for reverse repurchase agreements was $2,489.4 billion. Taking the difference between these two balances gives us the $624.8 reported above.

Regardless of the maturity of the repurchase agreements, the total reported on the balance sheet is the amount that balances the balance sheet at the close of business that Wednesday evening. It is a real number.

Fed Policy Stance

The Federal Reserve is attempting to bring actual inflation down to its policy target of 2.0 percent.

The Federal Reserve is attempting to achieve this result by raising its policy rate of interest and by reducing the amount of securities the Fed is carrying on its balance sheet.

Before the March 16 date, the Fed’s policy rate of interest, the effective Federal Funds rate stood at 0.08 percent.

Effective Federal Funds Rate (Federal Reserve)

There have been five increases in the effective Federal Funds rate beginning at the March 16 meeting of the Federal Open Market Committee.

There is another meeting of the Federal Open Market Committee next Tuesday and Wednesday, November 1 and 2, and it is expected that the FOMC will raise the effective Federal Funds rate by another 75 basis points.

There will be one more meeting of the FOMC this year in December and it is expected that the FOMC will raise its policy rate of interest by at least another 50 basis points.

To achieve and maintain these increases in its policy rate of interest, the Fed is reducing the amount of liquidity that exists in the banking system.

This is why the Federal Reserve is allowing securities to mature off its portfolio of securities purchased outfight.

As mentioned above, since March 16, $232.5 billion worth of securities have left the Fed’s balance sheet.

As mentioned above, the reverse repurchase agreements represent Federal Reserve sales of securities. But, the fact that the sale is connected with a repurchase of the securities means that reverse repurchase agreements are a liability of the Fed, and the securities sold by the Fed do not leave the security portfolios.

However, this liability represents a reduction in the amount of securities that are being counted as a security purchased outright, an asset, on the Fed’s balance sheet.

The use of reverse repurchase agreements help the Fed to manage the liquidity of the commercial banking system.

That is, if there are not enough securities leaving the Fed’s securities portfolio, the Fed can manage the amount of reverse repurchase agreements on its balance sheet to control the amount of liquidity that is in the banking system and can support the level of the effective Federal Funds rate now being controlled by the Federal Reserve.

Reserve Balances with Federal Reserve Banks (Federal Reserve)

Note how these Reserve Balances with Federal Reserve Banks has declined regularly with the fall in the effective Federal Funds rate.

But, the Federal Reserve wants to continue to keep the amount of securities on its balance sheet declining.

Right now, the Fed is using the approach called “quantitative tightening.”

Quantitative tightening occurs when the Fed regularly reduces the size of its balance sheet on a regular basis. When the Fed originally gave out the parameters for the quantitative tightening, it signaled that it would like to remove up to $95.0 billion in securities from its portfolio every month and would like to continue to do so into 2024.

Right now, the Fed is nowhere near achieving that total. But, it is reducing the size of its portfolio every month.

This “quantitative tightening” is not unlike the policies followed earlier by Fed chairs Ben Bernanke and Jerome Powell.

Mr. Bernanke, during his tenure at the Fed, oversaw three rounds of quantitative easing as the Fed pumped funds into the banking system to support rising stock prices and rising consumer spending.

Mr. Bernanke was very successful.

Mr. Powell, in the spring of 2020, in order to fight against the threatened collapse of the U.S. financial and economic system, oversaw the creation of another quantitative easing program, this time with the Fed purchasing $120 billion of securities for its portfolio for some 18 months.

Mr. Powell avoided a collapse of the U.S. financial system or the U.S. economy.

So, the quantitative tightening program is consistent with what the Fed has been doing over ten years or so, previous to 2020.

Two Questions

There are two questions, however, that remain unanswered.

First, how high will the Federal Reserve take interest rates?

Second, just how much liquidity will the Federal Reserve take out of the banking system.

If the Federal Reserve raises its policy rate of interest by 75 basis points next week and by 50 basis points at the December meeting of the FOMC, the effective Federal Funds rate will rise to 4.33 percent.

Some analysts have stated that they believe the Fed will take the policy rate of interest above 5.00 percent.

There are a lot of market participants that believe the 5.00 percent level is a little on the high side.

As far as the shrinking of the Fed’s balance sheet, the securities portfolio of the Fed now totals $8.3 trillion.

The earlier Fed releases on the shrinking of the Fed’s securities portfolio indicated that the Fed is hoping to reduce the portfolio to about $6.0 trillion.

This would be quite a move.

But, would it be enough.

And, what about reducing the amount of reverse repurchase agreements on the balance sheet?

Commercial banks now have $2.8 trillion in cash assets on their balance sheets. As can be seen in the accompanying chart, this amount of “cash’ has been built up over quite a few years.

But (and this is the reason for the extended time chart), the banks have not always been such hoarders of money. This “hoarding” has only come about in recent years.

Cash Assets with Commercial Banks (Federal Deposit Insurance Corp.)

However, the picture that is shown indicates that the commercial banking industry has lots and lots of liquidity.

So, the Fed’s efforts to shrink the liquidity in the banking system may require more action by the Fed than is currently planned.

There is still a lot to be done to straighten up the commercial banking system.

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