William_Potter
The personal consumption expenditures price index (“PCE”) rose in January, year-over-year, at a 5.4 percent annual rate.
Core PCE rose by 4.7 percent, a rise over the December number. Core PCE excludes food and energy prices.
PCE Price Index (Wall Street Journal)
As might be expected, stock prices dropped.
The S&P 500 Stock Index was down 60 points by 10:00 am.
Implication: Federal Reserve still has a ways to go in its battle to reduce inflation and, hence, the Fed will be raising its policy rate of interest for some time into the future and will continue to reduce the size of its securities portfolio.
This is not good news for the stock market.
Quantitative Tightening
The Federal Reserve reduced its securities portfolio by only a little bit in this past banking week.
Securities held outright declined by only $3.6 billion, bringing the total reduction in the securities since the “tightening” program began in the middle of March 2022 to $503.6 billion.
However, reverse repurchase agreements rose by $108.9 billion in the past banking week, drawing down bank reserves by a larger number.
Overall, reserve balances with Federal Reserve Banks, a proxy for excess reserves, dropped by just under $124.0 billion.
Apparently, at the current level of the Fed’s policy rate of interest, 4.58 percent, reserves had to leave the banking system in order to maintain the rate at this level.
The implication is that there is plenty of liquidity in the banking system and the effective Federal Funds rate would have fallen from its 4.58 percent level if the level of reverse repurchase agreements had not risen by the amount cited above.
In fact, since March 16, 2022, the level of reverse repurchase agreements has risen by $607 billion giving us some insight into how the Federal Reserve is managing the “tightening” program.
Yes, the Federal Reserve has reduced its securities portfolio by over $500 billion, but, helping to smooth the rise taking place in the effective Federal Funds rate, the Fed has had to oversee another decrease in reserves as reverse repurchase agreements have risen by $607 billion.
It should be noted that the Federal Government has returned just under $270 billion to the banking system in deposits, a movement that increased commercial bank reserves.
Since March 16, 2022, excess reserves in the commercial banking system, measured by the amount of Reserve Balances with Federal Reserve Banks have fallen by almost $910 billion.
Implications
One conclusion I draw from these numbers is that there is a tremendous amount of money available to investors in the American financial system.
The Federal Reserve is reducing the size of its balance sheet, but it is also relying on the “repo” market to take even more reserves out of the commercial banking system in order to maintain the Federal Funds rate at the level the Fed designates it to be.
The level of “reverse repos” on the Fed’s balance sheet is market-driven, but shows how liquid the financial markets are that such a large amount of “repos” are needed.
The quantitative tightening (QT) continues. The Federal Reserve wants to maintain its discipline on this part of its current policy program. Note the “steady” decline in the Fed’s securities held outright
Securities Held Outright (Federal Reserve)
Looking at this chart we can say that the Federal Reserve really wants to maintain a very disciplined approach to the actual reduction in its securities portfolio.
Obviously, the Fed is using the “repo” market to manage the amount of liquidity in the banking system and, in the current situation, oversee the reduction in bank reserve balances that are needed to support the level of the Fed’s policy rate of interest.
Problem
The Fed, itself, has, since the beginning of 2020, injected lots and lots of money into the banking system to avert a major financial crisis connected with the spread of the Covid-19 pandemic.
That is, the Fed, itself, created an asset bubble during this time period, something that I have written quite a bit about.
Now, as we know, the Fed is engaged in QT in order to reverse some of the problems that this asset bubble created.
There is another problem that analysts are now worried about…the asset bubbles that are being created by other central banks around the world.
Gillian Tett points to this problem in her column in the Financial Times this morning.
Ms. Tett writes about the liquidity that other central banks around the world are providing.
The Bank of Japan, the People’s Bank of China, and the European Central Banks have been pumping lots of money that is going into world markets.
Ms. Tett writes, “The net result is that these three central banks have collectively pushed almost $1.0 trillion of additional liquidity into the global system since October (when adjusted for exchange rates).”
“This more than offsets what the Fed has done. Call it, if you like, some accidental anti-QT.”
No wonder, she states, that the U.S. stock market has been on the rise since the middle of October.
S&P 500 Stock Index (Federal Reserve)
Note that the S&P 500 stock index (SP500) was at 3,584 on October 14, 2022 and closed yesterday at 4,014.
Wow!!! A 12.0 percent rise!
Ms. Tett closes her article with this suggestion:
“The key point for American investors is this: even as they track inflation data, corporate earnings and Fed speeches at home, they need to watch what [is going on elsewhere in the world].”
So, what does all this additional liquidity in the world mean to the Federal Reserve?
More work ahead.