The Effective Federal Funds rate stabilized in around 35 basis points in the latest banking week, up about 20 basis points from where it was two weeks ago.
The Fed Continues to remove reserves from the banking system in order to support this Increase, but it is still using “temporary” Measures to accomplish this.
The securities portfolio of the Fed has changed only modestly since the end of quantitative easing, and sooner or later, the Fed will need to begin to sell securities.
For the Federal Reserve Week That ended Wednesday, December 23, the Effective Federal Funds rate averaged 00:35 percent. This is up from the Fed week ending December 16, When The Effective Federal Funds rate averaged 00:15 percent.
To sustain this rise in its policy rate, the Federal Reserve with Drew almost $ 90.0 billion from the reserve balances That Commercial banks held at the Fed.
Reserve balances are a proxy for excess reserves in the banking system and on December 23 They totaled $ 2.371 billion.
The primary reason for the decline in reserve balances was an Increase in reverse repurchase agreements of almost $ 83.0 billion.
Reverse repurchase agreements is one of the “tools” being used by the Fed to remove reserves from the banking system on a short-term basis.
Over the longer run, the Fed HAS used a combination of These short-term tools alongwith other “operating” Factors to Achieve the reduction in reserve balances.
For example , over the past 13-week period, reserve balances have Decreased by a little less than $ 230.0 billion. Reverse repos rose by about $ 86.0 billion over this time span, while currency in circulation rose by $ 37.0 billion and deposits in the Treasury’s General Account at the Fed rose by $ 107.0 billion.
From watching These movements in the Federal Reserve balance sheet, It appears to be the case That the Fed Began Preparing for the current Interest Rate Increase early this case.
Commercial bank reserve balances at the Fed Began to show a significant decline in October 2015 .
After backing off from Increasing its policy rate in the first seven months of this year, Officials at the Federal Reserve Appeared ready to raise the rate at its September meeting.
The devaluation of the Chinese renminbi on August 11 and the Subsequent disruptions to World Financial Markets That Followed this move, produced Conditions That made it Difficult for the Fed to raise its policy rate. Consequently, it made no move at the September meeting.
It Seems, however, That the Fed Began to seriously begin preparing to raise the rate in October As It Began to cause the reserve balances of commercial banks to fall . This HAS resulted in the $ 230.0 billion decline in reserve balances since then.
Conditions were still not right to raise the rate at the Fed’s October meeting, but the Federal Reserve Continued to keep reserve balances from Increasing, Which wouldhave made it harder to raise the rate at its December meeting. By December, the Fed was ready to move, Officials felt confident That the banking system was in a shape to receive the Increase.
In allowingusers reserve balances to fall in this way, the Fed made use of regular ” operating “factors, as well as” temporary “Measures like the reverse repos to Reduce bank reserves without Causing much of a disruption to the operations of commercial banks.
Currency in circulation tends to Increase in a secular fashion with some seasonal “bumps,” like at Christmas time. Deposits into the Treasury’s General Account Usually Change for seasonal Reasons attached
to When taxes are Collected or When The government spends.
The Federal Reserve HAS operated in this way this time around in order to avoid any major financial reversals similar to Those That Happened During The 1930s. The Fed HAS made surethat most of the removal of Reserves HAS BEEN accomplished by “temporary” Actions That Can Be reversed as quickly as possible if problems are perceived.
Some day the Fed willhave to begin selling securities from its portfolio, but, to date, the policy Followed by its Officials ice to Note Reduce the size of the Fed’s securities portfolio.
The Federal Reserve HAS not used outright sales of securities to Reduce reserve balances. This is somethingthat Officials at the Fed have emphasized since the ending of its third round of quantitative easing in October 2014.
The Fed HAS especially refrained from Reducing the Amount of US Treasury securities from its balance sheet. On October 15, 2014, the date At which reserve balances peaked, the Fed held $ 2.455 billion US Treasury securities on its balance sheet. In just Replacing the volume of securities maturing, the Fed held $ 2.462 billion on its balance sheet.
The Fed’s holdings of US agency securities HAS Declined from just under $ 40.0 billion at the breading date to just under $ 33.0 billion now.
Holdings of mortgage-backed securities have Increased from $ 1.713 billion at the breading date to $ 1.758 billion now. The modest Increases here are Supplying a little bit of liquidity to the mortgage market.
So far the rate Increase has gone smoothly.
I believe That the Federal Reserve will continue to operate in This Way for the time being. What we want to watch for, however, is any signal from Officials at the Fed That They will replace the use of its “temporary” tools, like the reverse repurchase agreements and term deposits, and “operating” factors, with the use of an outright reduction in its securities portfolio.
The reduction of its securities portfolio Could take place in a calm fashion by allowingusers securities in the portfolio to mature without being replaced. This Could be Followed with a “planned” sale of securities, much as the Fed used “planned” Securities purchases in its quantitative easing.
Returning to a “more normal” Federal Reserve balance sheet is not going to ask an easy thing, and the Fed will be very cautious in moving in That Direction Because of its fear of moving too fast and creating a major disruption to the banking system.
