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Jerome Powell, Chairman of the Board of Governors of the Federal Reserve System, suggested towards the end of March this year that the Fed might begin a new round of quantitative tightening. He stated that starting from In June 2024, the Fed could begin reducing the value of the dollar securities it withdraws from its portfolio each month.
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The thinking seems to be that the Fed has been reducing the size of its securities portfolio at a fast enough pace for more than two years, and now, around June 2024, it can continue to reduce the size of its securities portfolio… but at a slower pace. Speed.
Well, here we are at the beginning of June 2024. The question now is… will the Fed actually slow the pace of the economy? Shrinking the size of its stock portfolio?
Looking at the Fed’s balance sheet on June 5, 2024, (see Fed Release H.4.1 dated June 6, 2024), we see that the Fed reduced its securities portfolio as of March 16, 2022, by $1,672.3 billion or less A little less than $1.7 trillion.
Reserve balances at commercial banks decreased by $435.7 billion, so that commercial banks now have approximately $3,457.7 billion, or just under $1.5 trillion, of “excess reserves.”
Looking at the Federal Reserve’s H.8 statistical release, “Assets and Liabilities of U.S. Commercial Banks,” we see that U.S. commercial banks hold $3,420.2 billion…or just over $3.4 trillion…in Their balance sheets for the week ending May 22, 2024.
This is only a reduction in reserve balances… or “excess reserves”… by $435.7 billion, or just over $0.4 trillion.
Monetary assets decreased by only $1,118.8 billion, or about $1.1 trillion.
The decline in the $1.5 trillion securities portfolio was offset by a $1.1 trillion reduction in the use of “reverse repurchase agreements” as administered by the Federal Reserve during this time period.
The Federal Reserve used the “reverse repo” facility to help manage the decline in securities held smoothly and ensure that the reduction in its securities portfolio did not get out of control and cause chaos in the financial markets.
The Fed has done a masterful job of implementing this process.
But the commercial banking system still holds nearly $3.4 trillion in “excess reserves” on its balance sheet.
As I have written repeatedly, this is a huge amount of liquidity in the hands of commercial bankers, and it represents money that banks and the financial system can use to support inflation… or to support high-priced assets such as those in the stock market.
The question I’ve been asked over and over again is…what is the Fed going to do about all this excess money in the banking system…money that was pumped into the banking system by the Fed during its response to the COVID-19 pandemic and the following recession?
What are Jerome Powell and all the other Fed officials going to do about all this “excess” money piled around the banks?
Well, Mr. Powell said that the Fed may start reducing the size of its stock portfolio each month.
Note that this says nothing about whether the Fed will cut interest rates.
Mr. Powell stated that the Fed may or may not cut interest rates this year. But there’s also the next question… How many times might the Fed cut interest rates in 2024?
Can’t underestimate it at all!
Will this make a difference?
Investors are still watching the Fed to see what will happen to interest rates.
If investors feel the Fed is going to cut interest rates…stock prices will rise.
If investors feel the Fed won’t move on interest rates… well, investors don’t seem to be too happy about that prospect… but investors still seem to be supportive of rising stock prices.
So, where does the Fed go?
For me, the interest rate decision is not important at the moment.
Moreover, with the presidential election approaching, the Fed may not want to start cutting interest rates because people may view this as a “political measure” used to support the incumbent president.
So, I will not address the interest rate issue anymore.
But the Fed has talked about starting to reduce the amount it cuts from its stock portfolio each month starting in June.
This is a change in policy. This is a new critical position.
I think it’s really remarkable that the Fed has been reducing the size of its portfolio of securities every month for 26 months now!
amazing! Who would have imagined that the Fed would remain steadfast in its “tightening” policy for such a long period of time?
This is really new.
But that’s how the Fed does business these days.
That’s why it’s so important for us to understand what the Fed does and why it does what it does.
It’s time to watch closely.
It would not be surprising if this move is merely an intermediate step towards a second round of quantitative tightening. This could be a move to put the Fed back in a position where it can start adding securities to its portfolio. This would naturally push the Fed’s policy toward quantitative easing.
Remember, before the COVID-19 pandemic triggered a round of very aggressive QE, the Fed had gone through three rounds of QE while Ben Bernanke was Fed Chairman.
Note that the key feature of this policy stance is the extended duration over which the Fed’s actions continue. Remember, the current period of quantitative tightening has lasted more than two years!
The Fed starts the “round” and then commits to policy for a long period. Investors come to “trust” the Fed and then move with the Fed’s actions.
This is what I think Ben Bernanke wanted to happen. This policy has been very successful over the past fifteen years. More on this in future posts.
But that’s where we seem to be. The Fed is ready to engage in another round of quantitative tightening in my view. The Fed will continue to reduce the size of its securities portfolio, but by less than it did over the past two years.
I believe that the new “round” will last for at least six months.
Then I think the Fed will return to a round of quantitative easing.
This seems to me to be the “new” world of monetary policy. So far, the “new” monetary policy structure has performed relatively well. Since the end of the Great Recession in the summer of 2009, the U.S. economy has sustained nearly 15 years of economic expansion with only two months of recession.
This included a period of severe economic turmoil associated with the spread of the COVID-19 pandemic.
So we will likely move on to the next ’round’. Investors should be especially aware of this step. Investors need to structure their strategies to “work” in this type of environment. This is the future.
