The Federal Reserve continued its quantitative tightening in the last banking week, overseeing a $16.1 billion decline in its securities portfolio.
From December 28, 2022, through January 25, 2023, the Fed’s securities portfolio has declined by $81.9 billion.
Since March 16, 2022, the securities portfolio has declined by $427.8 billion.
Here is how the reduction has proceeded.
This picture of quantitative tightening looks just like the inverse of the times when the Fed was engaged in quantitative easing.
The picture shows a steady decline in the securities portfolio, a decline that will continue as long as the Fed wants to continue to quantitatively tighten.
In the cases when the Fed was engaged in quantitative easing, the Fed continued the program longer than most analysts expected.
Now, in this case of quantitative tightening, the question is, how long will the Fed continue to oversee the decline in the securities portfolio?
There is no question in here about where the Fed’s policy rate of interest, the Federal Funds rate, will go.
Quantitative easing, and, quantitative tightening is continued for as the Fed believes it is necessary for them to continue.
Here the question is, about whether or not the Federal Reserve is shooting for a specific number, like in the current case of quantitative tightening, say a $1.0 trillion reduction in the securities portfolio.
This is the Fed’s goal, not a specific level for the effective Federal Funds rate.
So, keep an eye on the size of the Fed’s securities portfolio.
That is what Federal Reserve officials are doing.
What About The Federal Funds Rate?
The Federal Funds rate will be moved to achieve the market sentiment that the Federal Reserve officials want to maintain.
The quantitative tightening will continue, at whatever the rate is set.
Here, the important variable seems to be the line item on the Fed’s H.4.1 statistical release titled Reserve Balances with Federal Reserve Banks. This line item is more closely tied to the liquidity position of the commercial banks, and, hence, the level of the Fed’s policy rate of interest.
Here is what has been going on with Reserve Balances.
One can see how this is tied to the effective Federal Funds Rate.
Again, keep your eyes on the securities portfolio.
That is the essence of the Fed’s current policy stance.
Recently, however, there is a new factor entering into the picture concerning the Fed’s efforts at quantitative tightening.
This factor is very clearly discussed by Gillian Tett in the Financial Times.
“There is never a good moment for the U.S. government to hit its ceiling for debt issuance….”
“Now is a particularly inopportune timing….”
“The biggest reason to worry about the timing is that the financial system is at a crucial stage in the monetary cycle. After 15 years of accommodative monetary policy, during which the U.S. Federal Reserve expanded its balance sheet from $1.0 trillion to $9.0 trillion, the central bank is now trying to suck liquidity out of the system, to the tune of about $1.0 trillion a year.”
“The process is necessary, and long overdue.”
“But it was always going to be difficult and dangerous,.”
“And if Congress spends the coming months convulsed by threats of default the risks of a market shock will soar.”
“There are no easy solutions.”
“America’s monetary chickens are coming home to roost.”
And, so we move on to the next stage.
Debt and the mismanagement of debt, either from the treasury side of the issue or from the central banking side of the issue, always comes back to haunt you.