Federal Reserve Watch: ‘To Provide Ample Reserve Balances’

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Federal Reserve officials got a little “shock” in the banking week ending September 18, 2019.

The reserve deposits that the commercial banks hold at Federal Reserve banks, surprisingly dropped below $1.4 trillion.

This surprise caused Fed officials to go into “alert” mode and they responded with a substantial input of repurchase agreements, $75.0 billion to be exact, to “bump up” reserve levels and avoid any possible dislocation in the operations of the commercial banking system.

By the end of the next banking week ending September 25, the Fed oversaw an increase of reserve balances above $1.4 trillion. At the end of the next banking week reserve balances had returned to just below $1.5 trillion,

And, in the banking week, reserve balances ended the week at $1.528 trillion.

Now Fed officials have moved to “shore up” bank liquidity, indicating that the Fed would purchase around $60.0 billion of US Treasury bills every month until some time in the second quarter of 2020.

The Fed said the actions were “purely technical measures to support the effective implementation” of the rate-setting committee’s policy “and do not represent a change in the stance of monetary policy.”

The official press release of the Federal Reserve stated that

“In light of recent and expected increases in the Federal Reserve’s non-reserve liabilities, the Federal Reserve will purchase Treasury bills at least into the second quarter of next year in order to maintain over time ample reserve balances at or above the level that prevailed in early September 2019.”

The release further stated that the Fed’s

“intention to implement monetary policy in a regime in which an ample supply of reserves ensures that control over the level of the federal funds rate and other short-term interest rates is exercised primarily through the setting of the Federal Reserve’s administered rates, and in which active management of the supply of reserves is not required.”

In other words, the Fed didn’t want a disturbance like the one that happened in September to disrupt its ability to set and control its policy rate of interest.

In order to achieve this, the Fed believes that an “ample supply of reserves” will contribute to an environment that allows it to be in control of its policy rate and not let market forces divert it from Federal Reserve direction.

In this, the Fed is continuing to act in a way that errs on the side of monetary ease, rather than keep conditions too “tight” where “events” could produce a liquidity problem for the commercial banking industry.

The historical example to keep in mind is the 1937 situation in which Federal Reserve officials believed that the commercial banks were holding too many excess reserves. That is, the commercial banking system had built up its holdings of excess reserves far above historical levels and Fed officials believed that the level needed to be reduced so that the Fed could maintain its control of market conditions,

It turned out that the commercial banks had increased the desired amount of excess reserves it wanted to hold due to the financial crisis it had just gone through and when the Federal Reserve raised reserve requirements to reduce the level of excess reserves in the banking system, the commercial banks moved to bring excess reserves back up to their desired level.

As a consequence, bank lending collapsed and the US economy was thrown into another depression,

Federal Reserve officials have been very careful in the current recovery to avoid a situation like the 1937 situation. Therefore, they have taken up the stance that they would rather err on the side of monetary ease than attempt to reduce reserve balances below what the commercial banking system “desired” and create another banking crisis.

Fed officials seem to believe that the banking system was comfortable with reserve balances exceeding $1.5 trillion and only got nervous when operating factors took these balances below $1.4 trillion.

Now, the Fed is facing a rising federal deficit in which the US Treasury Department is going to be coming to market with more and more debt issues, a holiday season from mid-November through mid-January, and a tax season leading up to mid-April.

Add to these disruptions all the uncertainty that exists in the world today and you too, if you were a member of the Federal Reserve’s Open Market Committee, might be concerned about possible disturbances popping up here and there in the banking system and the financial markets.

It looks to me as if the Federal Reserve is being “very” protective of the economic recovery in acting in the way it is. But, Fed officials have a tremendous responsibility and are very much in the public spotlight at this time.

Federal Reserve officials, operating in a world never experienced before, a world that is almost overwhelmed with uncertainty, must be feeling that it is better to be safe than sorry.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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