Federal Reserve Watch: Jerome Powell Talking Up Volcker

Federal Reserve Building in Washington DC, USA

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Federal Reserve Chairman Jerome Powell speaks:

1. a half-point increase in the policy interval for the federal funds rate at the May meeting of the Fed’s Federal Open Market Committee;

2. plans, this will be formally announced at the May meeting, to “start reducing (the Fed) the $ 9.0 trillion asset portfolio in June”;

3. the image of former Fed Chairman Paul Volcker, “who aggressively raised interest rates in the early 1980s to end inflation.”

That equates to almost everything the financial markets want to hear about where the Federal Reserve is heading this year.

The only thing left out is how you will manage your balance sheet to achieve these goals. But hopefully, that information will be included in the Fed’s asset portfolio reduction plan.

Market response

Federal Reserve officials have been talking about moving their political tools since September 1, 2021.

At the time, the Fed decided to keep the effective rate of federal funds at 0.08 percent. And, it kept the rate at that level until the Federal Open Market Committee meeting in mid-March 2022.

Since that move, the effective rate of federal funds has remained stable at 0.33 percent.

A half-point increase in the Federal Fund rate target range would bring the range to a level of 0.50 per cent to 1.00 per cent at the May meeting.

Market rates have risen as the Fed’s intention and commitment to fight inflation has been stronger.

The yield on the 2-year U.S. Treasury bill has risen from 1.95 percent on the day the March rate hike was announced in March. Yesterday, at the close of the market, the 2-year yield was almost 2.60 percent.

The yield on the 10-year U.S. Treasury bill has gone from 2.20 percent in March to about 2.85 percent at the close of the market yesterday.

So it seems as if the Fed’s intentions are in line with market interest rates.

It is also possible to mention the behavior of stock prices.

The Standard & Poor’s 500 stock index hit an all-time high on January 3, 2022, at 4,796.56. Yesterday, the S&P 500 closed at 4,394.

The Federal Reserve, for much of the period from July 2009 to January 3, 2022, had been seen as the insurer of rising stock prices.

Earlier this year, when Fed officials talked about tightening their monetary effort and then moved on to make monetary tightening a reality, investors shied away from stocks.

The Fed’s position, as it stands, will cause stock market prices to fall even further.

Therefore, the reactions of the market are in line with the comments of Mr. Powell and will continue to move in the directions discussed as Federal Reserve officials make that effort.

I don’t expect Mr. Powell “pulls out a Paul Volcker,” but I do hope that for the time being he continues on the current path, with great care to avoid any collapse of the financial market.

The balance of the Federal Reserve

Last week, the Reserve’s balances with Federal Reserve banks fell by $ 466.4 billion, to reduce these “excess reserves” in commercial banks to $ 3.3 trillion.

Since December 29, 2021, these reserve balances have been reduced by $ 713 billion.

These falls have helped the Fed maintain the effective rate of federal funds at the levels described above. Indeed, this represents a tightening of the Federal Reserve in the reserve positions of commercial banks.

But because banks still have $ 3.3 trillion in excess reserves, the pressure on commercial banks … and financial markets … isn’t really that big.

This excess liquidity in the banking system will be one of the things that will make it so difficult for Mr. Powell and the Fed get what they seem to want.

It’s tax season!

One of the reasons these reserve balances have come down to the point is that it is tax season.

The Federal Reserve has the account from which the U.S. Treasury Department issues checks. This account is called the US Treasury General Account.

Usually, when people pay taxes, the funds go into the Treasury accounts of the participating commercial banks. Managing tax receipts in this way allows bank reserves to remain in the banking system. Keeping funds in the banking system will not affect the money markets.

Normally, this money is not transferred to the General Treasury Account until the Treasury wants to issue checks. Therefore, when the Treasury issues checks, they are deposited almost immediately into private bank accounts and, therefore, the balances of the reserves are not altered to any extent.

This time, however, it appears that tax receipts are being withdrawn from the commercial banking system and are being transferred to the General Account, leading to the withdrawal of reserves from commercial banks.

Last week, April 13-20, the general account rose by $ 364 billion.

Reserve balances with Federal Reserve banks

Overall, Reserve balances with Federal Reserve banks declined by $ 466.4 billion this banking week as reverse repurchase agreements reached another all-time high. Reverse replacements rose another $ 94 billion last week, to $ 2.164 trillion on the balance sheet as of Wednesday, April 20, 2022.

Thus, the Federal Reserve has been monitoring a reduction in the amount of “excess reserves” in the banking system.

But no effort has been made to reduce the amount of securities the Fed has bought “directly” that are on the Fed’s balance sheet.

We were promised in May a “plan” on how to reduce this portfolio.

And, this is where the banks and the financial system continue to “get liquidity.”

Since March 2, 2022, the Fed’s securities portfolio has grown by more than $ 53 billion. Since December 29, 2021, the Fed’s portfolio has grown by $ 226 billion.

This is one of the main reasons why the Fed has had to seek help elsewhere to drain reserves from the banking system.

The Fed has invested nearly a quarter of a trillion dollars in the banking system through direct securities purchases since the end of last year.

That is why it has had to find a way to remove the reserves from the banking system to keep the “excess reserves” down so that the effective rate of the Federal Funds can be maintained at the levels at which they were Found.

In this sense, the Federal Reserve has been fighting against itself.

I hope these days are over.

We expect the “plan” to indicate how the Fed intends to reduce the size of its securities portfolio, accommodate the “repo” market, and work around the Treasury Department’s management of its general account.

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