Will the Fed’s $4.5 trln bal­ance sheet mat­ter in its rate hike de­ci­sion?

Financial Mirror (Cyprus) - - FRONT PAGE -

This week will bring yet another FOMC meet­ing where the U.S. Fed­eral Re­serve will re­lease its de­ci­sion on in­ter­est rates for Fed Funds. Whether or not that new an­nounce­ment comes with a for­mal in­ter­est rate hike or not re­mains a point that is highly con­tested. What may mat­ter more than whether Fed Funds rise to 0.25% from a range of 0.00% to 0.25% is how the Fed­eral Re­serve will deal with the real quan­ti­ta­tive eas­ing is­sue co­nun­drum of what is close to a $4.5 trln bal­ance sheet.

Of that $4.5 trln, about $4.2 trln is held di­rectly se­cu­ri­ties. Those are Trea­sury debt, mort­gage-backed se­cu­ri­ties, and agency notes. Now con­sider that a uni­lat­eral rise in in­ter­est rates will hurt the value of the fixed coupons that it owns.

To put the bal­ance sheet of al­most $4.5 trln into con­text, we would use the bank JPMor­gan Chase’s bal­ance sheet for a ref­er­ence. The bank’s to­tal loan port­fo­lio was $791 bln – and its to­tal de­posit base was $1.28 trln. Wells Fargo’s to­tal loan port­fo­lio was $888.5 bln ver­sus a to­tal de­posit base of $1.18 trln.

That means





Fed­eral Re­serve’s as­set buy­ing un­der quan­ti­ta­tive eas­ing is worth more than five times the loan bal­ance of each Wells Fargo and JPMor­gan. It is also al­most 4-times the bal­ance of each bank’s to­tal de­posit base.

Now con­sider the Res­o­lu­tion Trust Corp. as a com­par­i­son from the late 1980s and 1990s. The bank as­sets from the nearly 750 banks and thrifts came with a to­tal as­sets of al­most $400 bln.

The good news here is that the Fed­eral Re­serve has a ten­ta­tive plan. Their web­site even out­lines this un­der a Mon­e­tary Pol­icy Nor­mal­i­sa­tion tab, as fol­lows:

“In re­sponse to the fi­nan­cial cri­sis, the Fed­eral Re­serve pro­moted eco­nomic re­cov­ery through sharp re­duc­tions in its tar­get for the fed­eral funds rate and through pur­chases of se­cu­ri­ties. When eco­nomic con­di­tions and the out­look for fu­ture eco­nomic ac­tiv­ity and in­fla­tion war­rant, the Fed­eral Re­serve ex­pects to start the process of nor­mal­is­ing the stance of mon­e­tary pol­icy and the size and com­po­si­tion of its bal­ance sheet. The tim­ing and pace of pol­icy nor­mal­i­sa­tion will be de­ter­mined so as to pro­mote the Fed­eral Re­serve’s statu­tory man­date of max­i­mum em­ploy­ment and price sta­bil­ity.”

The Fed’s July 29 FOMC state­ment also ad­dressed its bal­ance sheet pol­icy. It said:

“The Com­mit­tee is main­tain­ing its ex­ist­ing pol­icy of rein­vest­ing prin­ci­pal pay­ments from its hold­ings of agency debt and agency mort­gage-backed se­cu­ri­ties in agency mort­gage-backed se­cu­ri­ties and of rolling over ma­tur­ing Trea­sury se­cu­ri­ties at auc­tion. This pol­icy, by keep­ing the Com­mit­tee’s hold­ings of longer-term se­cu­ri­ties at siz­able lev­els, should help main­tain ac­com­moda­tive fi­nan­cial con­di­tions.”

Ad­di­tional nor­mal­i­sa­tion tools seem a bit dated from last year.

How the Fed will deal with un­wind­ing close to $4 trln worth of se­cu­ri­ties still for­mally re­mains to be seen. Maybe we should re­ally just ask whether that will take a mat­ter of years or whether it will take decades.


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