On Wednesday, March 16, the Federal Reserve raised its target range for the key interest rate, the federal funds rate, by 25 basis points to 0.25% to 0.50%.
The Federal Reserve also saw the effective federal funds rate rise to 0.33% for the entire banking week.
Thus, the Fed kept the effective federal funds rate at 0.08% from September 1, 2021 to March 16, 2022.
Now, it looks like the Fed will keep the effective federal funds rate at 0.33% for the time being.
Here is the table.
Federal Reserve officials have announced that they will raise this key rate up to five times this year.
If the Fed were to stick to increases of just 25 basis points, the range for the fed funds rate would drop from 1.50% to 1.75%.
Some officials, however, talk about the need to move the range by 50 basis points, at least twice, to bring the effective federal funds rate to a level that would be more effective in fighting inflation.
Federal Reserve Tapering
As noted, the Federal Reserve has reduced outright purchases of securities for its portfolio this year.
Since December 29, 2021, the Fed has purchased, outright, only $230.0 billion. Last year, it bought $120.0 billion a month.
So the Fed did exactly what it signaled to the financial markets it would do.
And, as promised, the Fed raised the target range for the federal funds rate at its March meeting of the Federal Open Market Committee.
But while the Federal Reserve was buying another $230.0 billion of securities, it was also selling, under a repurchase agreement, $134.0 billion of securities.
In addition, the federal government was removing $315.0 billion in reserves by transferring money from its accounts at the Federal Reserve to accounts in the private sector.
Net, from December 29, 2021 to March 23, 2022, the Federal Reserve oversaw a decline in reserve balances at commercial banks.
In other words, the Federal Reserve oversaw a decline in commercial bank reserve balances of just over $270.0 billion.
In other words, while the Fed was still buying securities on the open market, it was supervising the sale of securities to keep the federal funds rate at 0.08% until March 16 and to “goose” the rate. federal funds up to 0.33. percent since the increase in the target range.
Note that over the past two weeks, commercial bank reserve balances have fallen over the two weeks.
Reserve balances fell just over $60.0 billion in the banking week ending March 16 and fell again just over $124.0 billion in the banking week ending March 23.
This behavior, on the part of the Fed, raises questions about how the Fed will handle the battle against inflation.
The commercial banking system has nearly $3.8 trillion in Federal Reserve accounts.
This $3.8 trillion represents something like “excess reserves” for the commercial banking system.
The Federal Reserve, protecting the US banking system and the US economy, has put all of this money in bank accounts for the past two years as it strives to keep the economy and financial system healthy.
All this liquidity in the banking system is putting downward pressure on the Fed’s key interest rate.
And, as we’ve seen over the past year, the Federal Reserve has had to rely on the federal government and the repurchase agreement market to withdraw enough liquidity from the banking system to keep the federal funds rate from falling below 0.08 percent and now falling below 0.33 percent.
It would appear that the Federal Reserve cannot continue to sell securities in the repo market in order to keep the effective federal funds rate higher to support, perhaps, up to five more changes in the target range. of the Fed for the federal funds rate.
In other words, the Federal Reserve, at some point this year, is going to have to start reducing the size of its securities portfolio.
Fed officials suggested they could reduce the size of the Fed’s holdings of securities by letting securities mature, not replace them.
The question here is, will only maturing securities provide enough balances to shrink the portfolio to the size it needs?
My guess on this is that maturing securities won’t be able to do the job.
Thus, during this year, the Fed will have to start selling securities from its portfolio.
It will be a major gesture.
The Federal Reserve’s dilemma
More and more, people in the investment community are starting to realize that the Federal Reserve has created a situation that it will find difficult to resolve.
Since the beginning of 2020, the Federal Reserve has injected an excessive amount of funds into the banking system. Mr. Powell, in everything he has done, has continually tried to err on the side of monetary easing in order to avoid a situation where the financial system would suffer a shock that would collapse the system.
So far, Mr. Powell and the Fed have avoided this kind of calamity.
But, he now faces the problem of having to deal with “overcautiousness”.
In other words, the Federal Reserve created this situation and now the Federal Reserve has to get us out of this situation.
It’s not going to be easy.
And, in my opinion, it’s not going to be painless.
But, that’s where we are. And, we know so little about all the other factors that are going to impact our future.
In my opinion, the Federal Reserve is going to have to start reducing the size of its securities portfolio. This is the only way for it to raise its key interest rate.
I await Mr. Powell’s suggestion on how this is all going to be done.