Bank reserves are on track to approach a common estimate of the Lowest Comfortable Level of Reserves (“LCLoR”) within a few months. At the moment, reserves sit around $3.2t and a common Fed estimate places LCLoR at around $2.2t (8% of GDP). In addition to quantitative tightening, two events may soon reduce bank reserves to around $2.2t. First, the RRP is likely to steadily increase as MMF assets continue to rise and FHLB debt issuance declines. Second, the Treasury General …
Author: Joseph Wang
A wide range of data and commentary indicate that both the banking panic is over and that it had only a limited impact on credit availability. The March panic was fundamentally a problem of a few poorly managed banks and not a crisis. Investors are no longer running to money funds and now appear comfortable again with the banking system. Overall bank lending activity was little changed in March and continues to grow in April. A number of regional banks …
This post illustrates how banks deposits can be created, transformed, and destroyed. Banks deposits are the numbers in one’s bank account and the most common form of money. They are just digits in a bank’s database that are created when a bank makes a loan or buys an asset, and erased when a loan is repaid or when a bank sells an asset. They can also be transformed into other bank liability types when a bank borrows from investors. Bank …
All bank failures can be quickly papered over, except those that involve foreign currency. The authorities are well equipped to deal with domestic currency bank failures, where even the failure of a GSIB can be resolved and forgotten in a week. But the authorities cannot print foreign currency, and there are several trillion in uninsured dollar deposits abroad. A loss of confidence in regional U.S. banks raised the awareness of bank credit risk, and led to a shift out of …
There is little risk of a crisis in the banking sector, but that does not mean there aren’t badly run banks. QE and Basel III have made the banking sector significantly more liquid and resilient such that a replay of the GFC is very unlikely. However, individual banks under poor management can still be subject to bank runs. At a high level, a bank has short-dated liabilities and longer dated assets. A well managed bank holds enough assets to meet …
QT is incrementally improving the transmission of monetary policy by increasing the share of financial assets sensitive to the Fed’s policy rate. Although the policy rate is approaching 5%, trillions of bank deposits continue to offer around 0%. QT strengthens the transmission of policy by mechanically replacing bank deposits with policy rate sensitive Treasuries, and by forcing banks to compete more aggressively for deposit funding. Both outcomes raise the interest rate on assets held by non-Bank investors and will incrementally …
Governor Waller suggests two significant changes to the Fed’s QT framework that effectively removes all obstacles to an extended QT. First, Waller suggests that the $2t in RRP balances should be consolidated with bank reserves when thinking of bank liquidity levels. This indicates that the Fed would be comfortable with bank reserve levels dropping below the roughly estimated $2.5t minimum level. Second, Waller appears to be open to maintaining QT even if policy rates are cut. This would reverse longstanding …
A tremendous credit boom took place in 2022 and it may not even be over. The combination of healthy banks, financially strong households, and attractive rates appears to have to led to a surge in bank lending. Banks and credit unions together created $1.5t in cash last year that likely has not yet fully filtered into economic activity. Recall, bank lending creates money out of thin air. Interestingly, higher interest rates have so far only shown very tentative signs of …
A change in the underlying plumbing of the financial system is making it unlikely that QT can run its expected 2+ year course. An ideal QT would drain liquidity in the overall financial system while keeping liquidity in the banking sector above a minimum threshold. That is only possible if the bulk of the liquidity drained is sourced from the $2t RRP, which holds funds owned by money market funds. MMFs could facilitate QT by withdrawing funds from the RRP …
The stock effects of monetary tightening are clearly disinflationary, but the flow effects are less clear. The Fed’s rapid tightening markedly reduced the level of household wealth and thus potential demand, but the bulk of asset repricing seems to be behind us. The impact of tighter policy going forward is less certain because higher rates restrain some sectors but subsidize others. Interest income from reserves, RRP, and newly issued Treasuries rise along with rate hikes and can potentially increase demand. …