Fed can't keep the rates low

[DooDiligence]

Anecdotally, I was in both Lowes & Home Depot yesterday and they were packed.

 

Paid $51.98 per board for 3 pieces of 7.989 x 3.989 x 0.438 treated plywood.

[SharperDingaan]

Interesting, and very relevant, article in the Globe and Mail.

https://www.theglobeandmail.com/business/commentary/article-beware-the-bullwhip-effect-as-the-economy-springs-back-to-life/

 

Most would expect that coming out of Covid, we are going to see very high prices for some things ... as we see today for dimensional lumber, patio/driveway stone, and bicycles. Proof that inflation is here ,,, and in a big way! When it is really just evidence that supply chains are bullwhipping.

 

Correctly anticipate the direction, and you could do very well!

 

SD

 

[Cigarbutt]

I hear all of the arguments for deflation and increasing the money supply to match demand and I nod my head and generally agree.  But there are things that just don't pass the smell test.  For one, the case-schiller housing index is at an all time high while the housing component of the CPI is flat to down.  The C-S index is looking at actual home prices whereas the CPI housing component is calculating an "implied rent" which I can't figure out how it is determined.  The fed makes excuses for prices of things which are going up as supply side, so the market will work out supply issues?  Really?  How does that work, exactly, with natural resources? 

I also can't get past the idea that the dollar only has value if people have confidence in it.  Last year there was a run on toilet paper.  Part of the reason for the shortage was supply chain driven (people going to the bathroom more at home vs work or restaurants).  However, a large part of the shortage was due to people hoarding unnecessary amounts of toilet in fear that they would run out.  What happens if a critical mass of people (or foreign countries) lose faith in the dollar as a currency?  To me that's where all of this fancy money supply logic falls apart.

The fed can create as much money supply as it wants, but at the end of the day there is a risk of supply side inflation if not enough goods are produced in the real economy.

-This is interesting and relevant from my perspective because of expected (hoped for) real estate (residential and commercial) local opportunities in the coming months or years as a result of larger than regional market forces.

-On the CPI question and home prices

Is a home a consumer product, an asset or somewhere in between? People collecting data for the rent part put emphasis on surveys and the validity is questionable but may represent a better reflection of the intrinsic value of 'shelter' value over time vs the 'asset' value of homes which can deviate more and can be influenced by interest rate levels (2020 was a great example of that).

http://www.haver.com/comment/comment.html?c=210310SP.html

A reasonable conclusion is that both curves (value allocated to rent and market home prices) should tend to align over time. It's possible that housing prices have recently been going up as a result of pent-up demand and supply constraints (similar argument in the mid 2000s) but it's also possible that housing prices end up reflecting main-street and 'consumer' levels and the more intrinsic shelter value. (my bet is on the latter)

-On the "supply" issue

i don't have any insights about the long term fundamentals of toilet paper retail pricing but anecdotally think that prices have gone back to their longer term trends. When there were supply-type issues earlier in 2020, i faced very similar dynamics. There is a private venture that requires monthly purchases of medical supplies, some of which (consumers started buying some of these products) showed exactly the same pattern: for short periods, prices went up significantly or products were simply unavailable. However, prices in that segment are back to previous longer term trends. For this supply aspect and consumer prices, you have now people who find money in their pockets and there is a huge part of the population (hospitality, leisure, healthcare; all very low productivity areas and temporarily at risk for mismatch between expectations of the employer and the worker) who are going back to work. So, it's not surprising that there are and will be supply side pressures for temporary price increases but i doubt that these price pressures will be sustained.

 

[JRM]

I guess I feel like there has to be a critical flaw with modern monetary policy, I'm just not sure I can quite put my finger on it.  Just like the mantra of 'home prices always go up' leading up to the housing bubble, it seems likely that MMT has a similar flaw.  I think that critical flaw may be that confidence in the US Dollar is required to keep the game going.

 

Supply chain issues should be temporary and resolve over time; like the great toilet paper shortage of 2020.  But what happens if Biden signs an infrastructure spending bill that requires more physical resources than we are capable of producing?  One example would be declining silver production worldwide and increased demand (potentially) for solar panels, EV batteries, grid upgrades, etc.  Not to mention solar panels and wind turbines will likely need to be replaced after 20-30 years of operation.  My understanding is higher commodity prices are required to make recycling solar panels profitable at this point in time.

 

Despite all of the deflationary pressures that exist today, inflation seems like a good bet in the next few years.  Especially when the Fed has stated that inflation is their goal.

[SharperDingaan]

Keep in mind that temporary across-the-board supply chain price spikes, will show up in the CPI, and report as 'inflation'.

If the inflation is deemed too high, CB's will intervene. A bullwhip action begetting more bullwhip action .. and each iteration more powerful.

 

SD

 

[wabuffo]

I'm a monetary plumbing nerd and thus Thursdays are always an interesting day for me because the Fed publishes its weekly balance sheet as at Weds of this week (H.4.1) at 4:30.  That in addition to the Daily US Treasury Statement gives me some data that I like to look at. 

 

Well today's Daily Treasury Statement is a humdinger!  As indicated upthread, the US Treasury is trying to run down its account balance at the Fed by spending and then not issuing Treasury bonds to sop up its spending (and the bank reserves it creates with that spending.)

 

Cop a squint at today's report:

https://fsapps.fiscal.treasury.gov/dts/files/21031700.pdf

The TGA dropped by $271b.....in a single day.  There was hardly any Treasury debt issuance or redemption.  The US Treasury collected $17b in various cash receipts but SPENT $289.3b!  That's a one-day deficit of $271.8b.  In 2007, the US Treasury ran a deficit of $210b FOR THE WHOLE YEAR.  Here we did 30% better than 2007's annual deficit in a single day.  That must be a one-day record.

 

The main reason?  Look at the spending column under "IRS - Economic Impact Payments (EFT)" = $242b.  That's yer basic stimmy payments.

 

It will be interesting to see the Fed's report to see the impact on bank reserve growth since the US TGA balance in the Daily Treasury report will foot with the Fed's b/s on the same date. I expect bank reserves will be up to $3.9t on their way to over $5t by this summer.  The big banks deposit growth today must've been huuuge.  And Wells Fargo's Scharf is probably panicking right about now because he has to figure out how WFC will get back under the asset cap.

 

[EDIT:  Yep - bank reserves yesterday reached $3.87t.  They were $3.38t four weeks agao and $3.1t to start the year.]

 

Also as an aside - it appears the Fed will not give the banks continued SLR relief at the end of this month which surprises me.  So that will also squeeze bank balance sheets due to the increasing reserves and their counting against capital/leverage ratios.  This means that banks will be sellers of US Treasuries on their collective balance sheets (they hold collectively ~$1t), I believe.

 

Interesting times that's for sure for a macro money nerd like me.

 

wabuffo

 

 

 

 

[Cigarbutt]

^Some time ago, i had supplied the following quantitative input about fed easing:

Now this needs to be complemented by a quantitative treasury stimulus input:

The third (and last) cartoon is ready in the event of a potential outcome but won't be shared because of political correctess.

 

:)

[wabuffo]

really like the second cartoon (given my avatar  8) )

 

wabuffo

[Dalal.Holdings]

 

Also as an aside - it appears the Fed will not give the banks continued SLR relief at the end of this month which surprises me.  So that will also squeeze bank balance sheets due to the increasing reserves and their counting against capital/leverage ratios.  This means that banks will be sellers of US Treasuries on their collective balance sheets (they hold collectively ~$1t), I believe.

 

Interesting times that's for sure for a macro money nerd like me.

 

wabuffo

 

I don't know much about plumbing, but this guy seems to think the opposite:

 

And verily it was revealed unto the Kingdom that the SLR change was not UST bullish - no!

 

It was in fact UST bearish, for it had *reduced* the Tier 1 collateral requirements at banking institutions in an effort to allow banks to extend credit *instead* of holding USTs!

 

And so it was forseen that a reinstatement of the SLR requirements would roughly *triple* the UST requirements for the banks should it not be extended.

 

And, they surmised, it might lead to a contraction of previously extended credit lines as well (*cough* margin *cough*)

 

......

"For if the SLR is extended," the King continued, "this will do nothing at all to the demand for bonds that has not already been done, and if it is not extended this will bring about a glorious running of the bulls!"

11/

 

Basically--if I understand correctly-- what he's saying is pre-SLR change, banks needed tier 1 requirements of 3% of assets but SLR change decreased that to 1%. By ditching the SLR change, it will raise that back up to 3% and banks will be net buyers of US Treasuries...

 

 

 

[Cigarbutt]

Also as an aside - it appears the Fed will not give the banks continued SLR relief at the end of this month which surprises me.  So that will also squeeze bank balance sheets due to the increasing reserves and their counting against capital/leverage ratios.  This means that banks will be sellers of US Treasuries on their collective balance sheets (they hold collectively ~$1t), I believe.

Interesting times...

wabuffo

...

I don't know much about plumbing, but this guy seems to think the opposite:

...

i don't think the interpretation is correct.

Here's the SLR definition (by and large):

The supplementary leverage ratio is the US implementation of the Basel III Tier 1 leverage ratio, with which banks calculate the amount of common equity capital they must hold relative to their total leverage exposure. Large US banks must hold 3%. Top-tier bank holding companies must also hold an extra 2% buffer, for a total of 5%. The SLR, which does not distinguish between assets based on risk, is conceived as a backstop to risk-weighted capital requirements.

 

The 1.6T the Earl of Crayon refers to seems to be the amount of "space" that was created in banks' balance sheet when the Fed allowed to exclude the holdings of Treasury securities and cash/reserves to be included in the denominator.*

It's been reported that almost all banks currently meet the SLR requirement (it looked bad in Q1 2020 with many banks getting uncomfortably close to the 5%). It is estimated that the SLR ratio at banks will fall by about 90 basis points as a result of the expiration of the exclusion at the end of Q1 2021.

It's hard to explain why the Fed decided to let the exclusion expire because it's only a technical feature and by doing so, they are injecting a dose of uncertainty vs banks and the intent to accept deposits or to participate in the repo financing activities. It seems that the Fed responded to pollitikal pressures that wanted to keep the banks on a tight leash. Frankly, it's bizarre but they are the ones who painted themselves in a corner.

Just for fun, here is some data about excess reserves (this may be just noise and only interesting for those with an unusual interest in these topics but this may be history in the making):

From February 26 2020 to March18 2020, amount of systemic bank reserves created (as reported): 269B  (!)

From February 24 2021 to March17 2021, amount of systemic bank reserves created (as reported): 832B  (!!)

In the last week: 447B (!!!)

 

FWIW, it's hard to 'see' through the technical noise that may happen but, on a net basis, it seems that this will ultimately drive the demand for Treasury securities at the systemic level.

 

*This is really fascinating. The Fed (in collaboration with...) has been forcing banks to hold more capital and (since the GFC and now accelerating) has forced banks to stuff themselves with a huge amount of Treasury securities (in 2020, the largest 8 bank holdings increased this asset line item by 42% to 1.19T, with 41% of the increase by JPM) and, with the Treasury issuing record amounts of deposits, the Fed tells the banks (by not extending the exclusion) that they have to watch the growing size of their balance sheets as a result of growing holdings of Treasury securities and cash, arguably the safest and most liquid instruments in the world!  ???  The notion of balance sheet 'space' created by the exclusion is also fascinating when seen at the systemic level (banks can make individual changes at the expense of one another). Without money creation, all the banks can do is to perform asset swaps (sell a Treasury bond for slice in a CLO for example) and then their risk profile would increase. The banks are kind of stuck. In Q4 2020, Bank of America disclosed that loan growth was down from Q3 and it appears that money creation from loan growth at the systemic bank level (real economy stuff) continues to be disappointing. Most money creation is driven by the Treasury so that the only significant asset that could be used to fill the exclusion 'space' was new cash issued by the Treasury!

-----

Going back to a more mundane conceptual plumbing example, it looks like part (the real part) of the financial plumbing is getting clogged and the central plumber's solution is to keep flushing and now they are threatening to shut the cover. What could go wrong?

[wabuffo]

I don't know much about plumbing, but this guy seems to think the opposite:

 

He's confused and, in turn, he's confusing his twitter followers....

 

Basically--if I understand correctly-- what he's saying is pre-SLR change, banks needed tier 1 requirements of 3% of assets but SLR change decreased that to 1%. By ditching the SLR change, it will raise that back up to 3% and banks will be net buyers of US Treasuries...

 

I don't understand anything this guy's saying and I don't think he does either (you really should ignore those dudes on Real Vision). 

 

One can get lost in all of the mumbo-jumbo but its actually very simple conceptually.  Its all about leverage ratios, right?  Bank Assets/Bank Tangible Capital.  What everyone (including the bank regulators) learned in the GFC is plain old high-leverage kills banks.  The supplementary leverage ratio (SLR) just adds some off-balance sheet assets like derivatives and other adjustments and makes the numerator larger vs Tier 1 capital for systemically important banks.  It also adds in an additional buffer layer for safety and soundness (in effect forcing lower leverage for the Global - Systemically Important Banks (G-SIBs))

 

The key point is that in 2020, the actions of the Fed and the US Treasury dramatically expanded and converted the balance sheets of the big banks:

1) massive US Treasury deficit spending created new bank deposit liabilities with matching reserve assets.

2) Fed buying of US Treasuries swapped bank assets for additional reserves (which are frozen assets - kind of like restricted cash or cash that banks can't get rid of).

 

The Fed immediately worried that, all else being equal, big bank balance sheet leverage ratios were going to fall (ie, leverage was going to increase) because the assets were going to grow faster than tangible capital.  That turned out to be true.  The worry was the big banks were going to adjust by cutting assets - mostly lending.  Not what the Fed wanted to see.  So the Fed cut the banks some slack.  It said - let's not count reserves (no credit risk, no price risk) or US Treasuries (no credit risk, some price risk depending on duration) in your leverage ratios.

 

Let's look at a time series of some of the big banks (JP Morgan Chase and Bank of America - i'll ignore Wells Fargo because they have an asset cap which is a whole 'nother problem specific to them).  All amounts are $000s.

 

Here's JPM:

 

What do we see?  Jamie Dimon likes to keep his leverage ratio at about 9% (or assets/equity = 11x).  But we can see that assets exploded in 2020 (+26% Q4 '20 vs Q4. '19 while Tier 1 capital only grew +13%).  Without the waiver from the Fed, JPM's leverage would've increased to 12.7x and JPM would've probably taken action.

 

That's where the Fed's waiver kicks in.  I've broken out the quarterly balances for reserves and US Treasury security holdings for 2020 on the right.  When those balances are removed from the leverage ratio calculation, the "adjusted" leverage ratio comes back into line with JPM's historical performance.

 

BAC looks similar:

 

Ok - so here's the deal.  The Fed just removed the waiver (though they hint that they will take another look at SLR - possibly permanently exempting reserves? I guess we have a week and a half before the waiver expires so the Fed might issue new SLR guidelines before the deadline at the end of March).  The first impact if nothing else happens is what will the big banks do if their official leverage ratios indicate more risk to the regulators?  They are not in breach of SLR (they knew it was a temporary suspension so none of them did anything dumb) but the leverage is higher than they probably want so will they make adjustments?  They can't get rid of reserves in aggregate.  But they can shed US Treasury securities or worse (for the Fed) -- cut lending to lower-credit borrowers...eek!

 

Even with just the status quo at the end of 2020 and given the Fed's motivations, I was surprised the Fed reimposed the old rules (maybe JPow bent the knee to the Warren/Waters political faction?  So much for Fed "independence" from political interference? LOL.).  But the situation is not status quo in 2021.  The Fed (and we) know this.  It's going to get even worse for leverage ratios in 2021 for the big banks for three reasons:

 

1) The Fed will continue to expand its balance sheet with asset purchases - which stuffs even more reserves on bank balance sheets (though it doesn't grow assets - its a swap).

2) The US Treasury is still running "guns-hot" on spending.  That will create new bank deposits and reserves and will stretch leverage ratios beyond where they ended in 2020.  We could see another +20% growth in big bank assets in 2021  (sad trombone music for Wells Fargo and their asset cap would be an appropriate soundtrack right about here  8) )

3) The US Treasury also has a one-time problem of getting its extremely large Fed general account balance way the heck down by late July when the Congressional Debt Ceiling toggles back on.  This will push reserves into the banking system (and deposits) which the Treasury will not relieve with as much Treasury debt issuance as a reserve maintenance activity.  Yet more reserve growth in 2021 - just what the banks don't want and can't use.

 

So its a double-barreled problem for the big banks.  How they choose to solve being "offsides" on their leverage ratios will create macroeconomic cross-currents in 2021.  They could shed assets.  Or (as the Fed would likely prefer). banks could raise more capital either by maybe issuing preferreds (which still count as tangible equity, I think?) or worse for investors, they could cut dividends and share repurchases in order to rebuild equity capital.  I don' think Jamie Dimon thinks he needs more capital and he has been known to signal his displeasure at the Fed and bank regulators by allowing the market and economic blow-back of Fed regulatory decisions to boomerang right back to the Fed (see also, Sept 2019 bank reserves/repo mess).

 

In fact, Dimon in JPM's Q4, 2020 earnings presentation fired a shot across the Fed's bow with this slide:

 

Should be an interesting spring and summer for monetary geeks and freaks like us!

 

wabuffo

 

EDIT:  You know what?  Let's cop a squint at WFC's numbers:

 

Oh man - you can just feel the pain at Wells because of the asset cap!  Now imagine another doubling of reserve assets in 2021!  At Q1, 2018, WFC had 70% of the assets that BAC did.  Another year of 20% asset growth at BAC vs 0% at WFC, and WFC will have shrunk to 40% of BAC's asset size!

[Dalal.Holdings]

I don't know much about plumbing, but this guy seems to think the opposite:

 

He's confused and, in turn, he's confusing his twitter followers....

 

Basically--if I understand correctly-- what he's saying is pre-SLR change, banks needed tier 1 requirements of 3% of assets but SLR change decreased that to 1%. By ditching the SLR change, it will raise that back up to 3% and banks will be net buyers of US Treasuries...

 

I don't understand anything this guy's saying and I don't think he does either (you really should ignore those dudes on Real Vision). 

 

Let's look at a time series of some of the big banks (JP Morgan Chase and Bank of America - i'll ignore Wells Fargo because they have an asset cap which is a whole 'nother problem specific to them).  All amounts are $000s.

 

wabuffo

 

Thanks, that's helpful (more to chew on).

[Spekulatius]

In principle, JPM and peers could turn down deposits? Now that would be interesting - we have enough money, we don’t want yours, take it somewhere else

[hasilp89]

In principle, JPM and peers could turn down deposits? Now that would be interesting - we have enough money, we don’t want yours, take it somewhere else

 

Is that an intentional byproduct of fed policy? Almost acts like negative interest rates right - incentivizes spending/investing money?

[wabuffo]

In principle, JPM and peers could turn down deposits? Now that would be interesting - we have enough money, we don’t want yours, take it somewhere else

 

Is that possible?  The deposits (and reserves) never leave the banking system.  JPM sends the deposits to Wells who can't keep them who sends them to BAC...who sends them to?  JPM?  Whoever gets them has to have a reserve account at the Fed.

 

Is that an intentional byproduct of fed policy? Almost acts like negative interest rates right - incentivizes spending/investing money?

 

For every buyer there is a seller.  If I spend my stimmie cash, someone else receives the stimmie cash (and the deposit).  The deposits (and reserves) once again just move around, they don't get removed or destroyed.

 

I think the only way the deposits (and reserves) leave the system is if they are converted to US currency or are removed by the US Treasury via bond issuance. 

 

wabuffo

[Cigarbutt]

In principle, JPM and peers could turn down deposits? Now that would be interesting - we have enough money, we don’t want yours, take it somewhere else

Is that possible?  The deposits (and reserves) never leave the banking system.  JPM sends the deposits to Wells who can't keep them who sends them to BAC...who sends them to?  JPM?  Whoever gets them has to have a reserve account at the Fed.

Is that an intentional byproduct of fed policy? Almost acts like negative interest rates right - incentivizes spending/investing money?

For every buyer there is a seller.  If I spend my stimmie cash, someone else receives the stimmie cash (and the deposit).  The deposits (and reserves) once again just move around, they don't get removed or destroyed.

I think the only way the deposits (and reserves) leave the system is if they are converted to US currency or are removed by the US Treasury via bond issuance. 

wabuffo

The "we will have to refuse deposits" narrative may be a negotiation tactic and reflects the tight space for banks in terms of core profitability. Starting in 2017 (with the timid attempt to tighten), the Fed started to increase significantly the yield (following the effective fund rate) paid on excess reserves and this, compared to underlying funding cost of deposits (using MMDA "high-yield" as a reference point which did not really increase significantly), banks were able to earn up to about 200 basis points differential in 2019 on the excess reserves part of their assets. During 2017-2019, excess reserves were still a significant part of total assets and this helped significantly for the NIM and ROE measures. But with 2020, this free-lunch type of return is gone with IOER being lower than median deposit costs for big banks. A way to deal with this may be inspired by what the BOJ has been doing for a while with negative interest rates and their three-tiered excess reserves system. The BOJ has adjusted the interest actually paid on reserves in order to help banks. With short term inflationary pressures, the banks are being financially repressed and maybe they can negotiate some kind of CPI-related yield on at least a part of the excess reserves (which are not leaving anytime soon).

[wabuffo]

CASH (Meta Financial) just got the nod (for the third time in three chances) to be the official "stimmie" prepaid card issuer on behalf of the US Federal government.

 

https://www.metafinancialgroup.com/news-releases/news-release-details/metabankr-serves-agent-distributing-prepaid-debit-cards-part-0

 

Reinforced by the Company’s mission of enabling financial inclusion, the Bank will disburse approximately $11 billion of EIP on Bank-issued prepaid cards in the third round, with initial payments beginning after March 22, 2021. This distribution builds upon the stimulus provided in the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) from March 2020 and in the Consolidated Appropriations Act of 2021 (“CAA”) from December 2020. Under the CARES Act, the Bank disbursed $6.4 billion through the distribution of 3.6 million Bank-issued prepaid cards for the first round of EIP and, through the CAA, disbursed $7.1 billion of the second round of EIP through the distribution of 8.1 million Bank-issued prepaid cards.

 

CASH runs with a balance sheet size typically at around $6b in assets, so for CASH to get a transfer of deposits/reserves via the US Treasury's general acct at the Fed of $11b so close to quarter-end will be instructive to show how our monetary system works.  This $11b is on top of the $7.1b CASH got in January in the second round of stimmie which probably has not been fully run down as yet.  Heck - I think there's still some deposits left over from last year's first round of stimmie in Q2, 2020. 

 

While these reserves and deposits will run down as prepaid card recipients get their cards and spend their balances (these balances will transfer to other banks who represents merchants/service providers who sell the stuff that these prepaid card recipients spend their card balances on) - what we should see on CASH's balance sheet at 3/31 is a massive (and I mean massive) "cash balance" of probably two-thirds the total of CASH's entire asset base.  Of course, deposits will be equally huge as well.

 

When the quarterly report comes out, we'll revisit this.... I think it will be quite a good case on how the Fed, US Treasury and bank money flows work.

 

wabuffo

[Cigarbutt]

CASH (Meta Financial) just got the nod...

CASH runs with a balance sheet size typically at around...

While these reserves and deposits will run down as prepaid card recipients get their cards and spend their balances (these balances will transfer to other banks who represents merchants/service providers who sell the stuff that these prepaid card recipients spend their card balances on) - what we should see on CASH's balance sheet at 3/31 is a massive (and I mean massive) "cash balance" of probably two-thirds the total of CASH's entire asset base.  Of course, deposits will be equally huge as well.

When the quarterly report comes out, we'll revisit this.... I think it will be quite a good case on how the Fed, US Treasury and bank money flows work.

wabuffo

This is interesting. It looks like the regulators will collaborate for the technical adjustments but this is quite unusual.

Under the previous era (no excess reserves), banks typically always had to monitor the quality (duration) of their deposits and could use derivatives to protect against an unexpected movement of deposits (and associated cash balance) with the run on the bank as the most extreme example but now with excess reserves and highly capitalized capital structures, apart from the SLR technicality, banks such as CASH have ample cash balances to deal with the expected short duration of a significant amount of 'deposits'.

CASH reported that they will consider synthetic transfers (off-balance sheet) of some of their deposits (as part of the changing regulatory landscape). It's hard to guess the specifics of potential off-balance sheet transactions but, even if the deposit cost is 0%, the value of the derivative transaction would be positive (barely) because the matching cash asset is deposited at the Fed and pays 10 basis points. Funny world we live in. Just imagine if rates are pushed in negative territory.

This is preliminary but CASH has an unusual setup for maturity transformation but perhaps the 'story' here is with the potential for non-interest income.

This way warrant its own thread eventually.

 

[wabuffo]

Quick Fed update.

Total US Commercial Banking Industry Reserves (i.e., illiquid deposits stuck at the Federal Reserve) are about to top $4 trillion. (per yesterday's H.4.1 report)

https://www.federalreserve.gov/releases/h41/current/

Bank's are getting a triple scoop of (unwanted) reserve growth at the moment:

1) continued US Treasury deficit spending due to stimulus creates new bank deposit liabilities + federal reserve assets.

2) continued Fed open market purchases of Treasury assets is swapping those purchased assets for a reserve asset.

3) a new factor is the US Treasury's need to run its account balance at the Fed down to a target of ~$117b before August 1st, 2021 when the Congressional Debt limit toggles back on (unless Congress extends it).  At the moment, that balance sits at a bit less than $1t, and the US Treasury is starting to run it down.  This means that for every dollar that the TGA balance goes down, bank reserves go up a dollar.  This is because the US Treasury is spending but then not issuing a corresponding US Treasury security to soak up the reserves its spending is creating.  (BTW - this is a real-time MMT lesson that demonstrates how US Treasury issuance isn't really borrowing, it is a reserve hygiene maintenance operation).

Here is a chart that I created from the weekly Fed H.4.1 balance sheet report since the start of 2020.   The orange line is the actual weekly total reserve balances by the US commercial banking sector on deposit at the Fed.  The blue line is what it would've been if, in theory, the US Treasury stayed at its Aug 1st to-be target of $117b.   You can see that the US Treasury really ran up its TGA balance during the pandemic, kept it high, but now is starting to run it down and the two lines are starting to converge.

It does look like banks are heading to $5t of total reserves vs $21t of total assets.  How far will this go?  No idea - but its nuts.  The good news is the banking sector is super-low risk.   The bad news is return on assets and return on equity is gonna suck.

wabuffo

Edited April 9, 2021 by wabuffo

[Cigarbutt]

It's not clear if this is a mainstream topic or even relevant (and available time for this area is kept under 1%) but this is getting really weird. No?

There's this recent piece which some may find interesting (it contains some interesting bank data and suggests an unusual solution) and which reveals how 'disconnected' (IMO) monetary authorities have become.

The author (who likely is very bright and has noble intentions) basically suggests (to 'solve' the SLR technical features related to our new monetary era) to the Treasury to issue extra debt (overfund) to 'others' and use the cash in order to buy the treasury debt held by the Fed as a result of cumulative QEs. In the early 2000s, American monetary guiding lights went to Japan to tell them that they were extending and pretending..

https://voxeu.org/article/unstuffing-banks-fed-deposits-why-and-how

[TwoCitiesCapital]

3 hours ago, wabuffo said:

Quick Fed update.

Total US Commercial Banking Industry Reserves (i.e., illiquid deposits stuck at the Federal Reserve) are about to top $4 trillion. (per yesterday's H.4.1 report)

https://www.federalreserve.gov/releases/h41/current/

Bank's are getting a triple scoop of (unwanted) reserve growth at the moment:

1) continued US Treasury deficit spending due to stimulus creates new bank deposit liabilities + federal reserve assets.

2) continued Fed open market purchases of Treasury assets is swapping those purchased assets for a reserve asset.

3) a new factor is the US Treasury's need to run its account balance at the Fed down to a target of ~$117b before August 1st, 2021 when the Congressional Debt limit toggles back on (unless Congress extends it).  At the moment, that balance sits at a bit less than $1t, and the US Treasury is starting to run it down.  This means that for every dollar that the TGA balance goes down, bank reserves go up a dollar.  This is because the US Treasury is spending but then not issuing a corresponding US Treasury security to soak up the reserves its spending is creating.  (BTW - this is a real-time MMT lesson that demonstrates how US Treasury issuance isn't really borrowing, it is a reserve hygiene maintenance operation).

Here is a chart that I created from the weekly Fed H.4.1 balance sheet report since the start of 2020.   The orange line is the actual weekly total reserve balances by the US commercial banking sector on deposit at the Fed.  The blue line is what it would've been if, in theory, the US Treasury stayed at its Aug 1st to-be target of $117b.   You can see that the US Treasury really ran up its TGA balance during the pandemic, kept it high, but now is starting to run it down and the two lines are starting to converge.

It does look like banks are heading to $5t of total reserves vs $21t of total assets.  How far will this go?  No idea - but its nuts.  The good news is the banking sector is super-low risk.   The bad news is return on assets and return on equity is gonna suck.

wabuffo

I was listening to a podcast recently that was simply focused on the QE portion of the equation, but was arguing that we are currently in a liquidity trap.

Basically the guy was saying 

1) QE is limited in its scale by bank deposits because those bank deposits are what banks use to buy the treasuries to flip to the Fed

2) This is why we need fiscal spending - so more cash is injected into the system to be deposited into banks to grow those deposits to allow QE to continue

And 3) once that treasury bond is flipped to the Fed, the cash is trapped. Cash goes to the dealer bank to be used at the next auction to buy more treasuries. The buying bank who flipped to the Fed only receives a reserve that can't be loaned or withdrawn and the principal/interest payments on the Treasury are paid to the Fed and don't enter circulation. 

Basically his argument is QE is deflationary as it sops and locks trillions of dollars OUT of the real economy and that number grows every day resulting in a dramatically lower velocity to the dollar, a shortage of dollars that drives the value of the dollar higher, and lower interest rates. All of which are disinflationary/deflationary. 

Would you say this is what we're seeing now with the explosion of excess reserves? 

[wabuffo]

Basically his argument is QE is deflationary

I don't really agree with this.  As you said, this person's argument seems to miss the actions of the US Treasury.  I think most people do when they talk monetary policy.  Here's what is/would be deflationary.   If the US Government (and therefore the US Treasury) ran a multi-year surplus at the Federal level - like we did in 1998-2001.   With a surplus, tax receipts (and other Federal govt fees, levies and judgements paid) exceed spending.   This removes bank deposits from the banking system and creates a dollar asset "shortage" which led to the deflationary recession of 2000-2002.  Recessions lead to a dramatic reduction in tax receipts, which flips the US Treasury back into a deficit -- and the economy is tipped back upright again.

What I would say is that QE suppresses interest rates which as I've said before hurts savers more than it helps debtors.  Savers seeing a loss of interest income, save even harder - which, in turn, hurts consumption and economic activity.  That's not deflation though - that's just lowering GDP growth.

Basically some days I wish the Fed would just fire all of its PhD economists and retain only a small staff to help the Fed Chairman, who I would, in turn, lock out of his/her office from 9 to 5 (when markets are open).   LOL.

wabuffo

Edited April 9, 2021 by wabuffo

[Cigarbutt]

^QE is simply an asset swap, a swap that doesn't square well with points 1), 2) and 3).

There are no clear upper limits to QE as long as technical (financial plumbing) issues are adjusted (ie bank ratios etc) and unseen side effects remain unseen. Restraints at this level have to be intrinsic (the 1913 Federal Reserve Act is interesting in that regard).

There are two 'monetary' cycles (the inner Fed to banks cycle and the real economy cycle) with an intersection in commercial banks and subsidiary dealers. The central banks are finding out that they have very little influence on the real economy cycle in terms of the banks' willingness to lend or of the real demand from market participants, apart from low interest rates which may be considered as a sign of sophistication or recklessness. i guess we'll eventually find out.

The most sympathetic interpretation is that central banks' actions no longer have real effects but i wonder if real consequences are only delayed (this is typical for diabetics, drug addicts etc)

Edited April 9, 2021 by Cigarbutt

[wabuffo]

Hey CB - finally had a bit of time to read the article you posted...

suggests (to 'solve' the SLR technical features related to our new monetary era) to the Treasury to issue extra debt (overfund) to 'others' and use the cash in order to buy the treasury debt held by the Fed as a result of cumulative QEs.

We may disagree about motivations, but I think this is basically what the US Treasury did in 2020.  It issued ~$1.8T more in US Treasury securities than it needed vs its net spending.   This grew its Treasury general account to as high as a $1.8T balance.   I still believe this was done to take the pressure off the banks in terms of reserve balance growth (basically banks would've had $1.8T more in reserves if the US Treasury had not done this).

Now whether or not the US Treasury turns around and uses its large TGA balance to "buy" the Fed's holdings of US Treasury assets really doesn't matter (and the author of the article admits as much when he says that in his proposal the US Treasury can just sit on the large balance).  

It just goes to show how ineffective and counter-productive the Fed's QE policy is.  More importantly, anyone who claims that the Fed is "monetizing" the US Treasury's deficit spending is betraying a lack of clarity over what is really happening here.  The same effect can be achieved by letting the US Treasury deficit spend without issuing a commensurate amount of US Treasury securities to "finance" that spending while the Fed goes to the sidelines (which is what is happening in 2021, sort of....).

wabuffo

Edited April 10, 2021 by wabuffo

[Cigarbutt]

21 minutes ago, wabuffo said:

...We may disagree about motivations...

wabuffo

i think what we disagree about is the lack of motivation.

A lot of the confusion is about semantics. The Fed does 'create' currency (but as a swap to an asset of different duration which is also recorded). 

As a coincident evolution or as a contributory effect, central banks' fixation on low interest rates have been linked to gradually lower real yields. It's still not clear what this means.

https://ggc-mauldin-images.s3.amazonaws.com/uploads/newsletters/Image_11_20210410_TFTF.png

Your reserves management hypothesis may be partly or even mostly correct. Only a handful of people would know. Last March, there were many questions (that remained unanswered) concerning potential mark to market adjustments (write-downs) and many 'precautionary' moves were activated in the direction of further easing. Of note, in the last week, reserves in the US financial plumbing system increased by 438B. When housing prices declined during the GFC, the Fed strategy was to increase reserves. When housing prices record record YoY price increases, the Fed strategy is to increase reserves. Go figure. When everything looks like a nail...