Thanks for another very interesting article. I'm no expert on this subject, but it seems to me the process you describe is not stealth easing by the Fed. It's fiscal stimulus by the Treasury, counteracting the Fed's tightening. It's the Treasury that issues the T-bills that are pulling money out of the RRP into the TGA. And, if I'm not mistaken, it's the money spent by the Treasury into the economy that ends up as incressed bank reserves (balancing the banks' increased liabilities in the form of deposits).
The Fed's balance sheet is a grey area where fiscal and monetary policy meet. It's important, because as you alluded to, the way government spending passes through the Fed is a key factor in determining how stimulative it will be.
It has become more important in the QE/QT era where the Fed, and other central banks, are using unconventional monetary policy tools
The RRP has exploded in size since 2021 when the New York Fed announced two new standing repo facilities -- one for domestic counterparties (larger one) and one for non-US counterparties (smaller and more stable). So, at the end of February 2021 RRP held $205 billion, exploding to over $1.9 trillion by the end of that year and $2.677 trillion at one point this year.
Much of the growth in RRP was the result of an increase in money market fund assets due to COVID-related stimulus for consumers and businesses. Also, since commercial banks were very slow to raise deposit/savings rates when interest rates rose, money market fund assets increased as an alternative to traditional bank savings deposits. That trend accelerated with the regional banking mess earlier this year.
So, in a sense, a lot of the 2020-21 fiscal stimulus ended up parked in money market funds and RRP.
When most governments borrow money they do so to spend it and, certainly, I think that's more than fair to say for the US right now. And, theoretically, when the government spends money it's pushing it back into the economy, creating/stimulating economic activity. Traditionally there's also an assumed multiplier effect -- government spending ends up in consumers' pockets and then their spending/investment also creates economic activity.
But, the government doesn't create wealth or earn money, so they have to get the money they spend from somewhere -- basically either taxes or borrowing.
So, assume the government decides to spend money and raise taxes to fund it. That creates forces pulling in opposite directions -- higher taxes pulls money out of the economy (negative for growth) while more government spending is generally good for growth.
If the government decides to borrow the money then it really is a question of how they do so and whether the Fed accommodates it. Under QE it didn't matter -- the Fed was buying up Treasury securities so quickly the size of the deficit didn't really matter (at least not immediately) and rates were ultra-low.
When QE ended, this became a more complex question. If Treasury borrows using long-term bonds or Treasury Notes, then the money would most likely come out of US commercial bank deposits. Yes, it could also come from foreign entities/central banks buying Treasuries, but they've generally been net sellers of late.
And then you have an opposing forces problem again. Bank reserves are called "high-powered money" (you'll still see that term occasionally though it's less common than it was some years ago). The reason is the fractional reserve banking system creates its own multiplier effect -- a bank might take in $100 in deposits and those reserves back up $200 in loans for example. That credit then funds consumer spending, home buying, business investment, capital spending, etc, which creates wealth and more deposits and loans.
So, when Treasury borrowing drains reserves near-term, it becomes a question of whether government spending has a greater or lesser multiplier than private credit. That's a pretty complex topic and one where there's wide disagreement to say the least.
To further complicate matters, when Treasury borrows money in this way, it will also tend to push up interest rates across-the-board which depresses economic activity, particularly when there's a lot of credit in the system.
Also, note that some Treasury spending is actually tax credits -- so the money doesn't get spent unless it's pulled by private sector spending. For example, an offshore wind project with tax credits under the Inflation Reduction Act (IRA). If interest rates go up too much it's likely the project won't make sense even with tax credits, so it gets canceled. So, the effect of greater Treasury borrowing is actually to kill some of the investment they're trying to encourage.
Certainly, what I can tell you is that in the QE/QT era rising bank reserves tend to correlate with a strong stock market -- that's the regression I did in the article. The opposite is also true -- falling bank reserves is bearish for stocks.
In this case, Treasury has relied heavily -- far more than normal -- on short term funding (T-Bills) so that their borrowing ($1 trillion in some quarters) won't hit bank reserves or cause a large spike in rates. They have actually had a few auctions "tail" in recent months, meaning that demand was weak and they had to pay a higher rate than expected.
The only reason the T-Bill strategy is working is that the Fed has created a sort of "honey pot" of cash in the form of RRP the government can borrow from via money markets.
So, in the sense that some of the money in RRP is a function of government spending you could say that's fiscal stimulus. You could also say that since RRP is blocking some of the normal transmission mechanisms for tightening monetary policy in the QE/QT era, it's a form of subtle monetary stimulus.
The risk longer term is what happens when RRP is exhausted. Do we see a sudden spike in rates because it becomes more difficult for Treasury to borrow, coupled with a decline in bank reserves/tightening in credit. Or is it gradual enough to be manageable.
Does the Fed have to cut rates -- even restart QE -- because Treasury auctions get too messy for comfort? The problem here is that US Treasury securities are so important to the global financial system it really won't work to have them trading like a "meme" stock.
I don't think anyone really knows the answer to that because it's never happened before in quite this way, but I suppose we're going to find out in the next few months.
My fear is that economic trends and credit events have a nasty tendency to be non-linear -- what seems to be a gradual shift can suddenly accelerate or create a Black Swan event.
Thanks for another very interesting article. I'm no expert on this subject, but it seems to me the process you describe is not stealth easing by the Fed. It's fiscal stimulus by the Treasury, counteracting the Fed's tightening. It's the Treasury that issues the T-bills that are pulling money out of the RRP into the TGA. And, if I'm not mistaken, it's the money spent by the Treasury into the economy that ends up as incressed bank reserves (balancing the banks' increased liabilities in the form of deposits).
Thanks for the comment.
The Fed's balance sheet is a grey area where fiscal and monetary policy meet. It's important, because as you alluded to, the way government spending passes through the Fed is a key factor in determining how stimulative it will be.
It has become more important in the QE/QT era where the Fed, and other central banks, are using unconventional monetary policy tools
The RRP has exploded in size since 2021 when the New York Fed announced two new standing repo facilities -- one for domestic counterparties (larger one) and one for non-US counterparties (smaller and more stable). So, at the end of February 2021 RRP held $205 billion, exploding to over $1.9 trillion by the end of that year and $2.677 trillion at one point this year.
Much of the growth in RRP was the result of an increase in money market fund assets due to COVID-related stimulus for consumers and businesses. Also, since commercial banks were very slow to raise deposit/savings rates when interest rates rose, money market fund assets increased as an alternative to traditional bank savings deposits. That trend accelerated with the regional banking mess earlier this year.
So, in a sense, a lot of the 2020-21 fiscal stimulus ended up parked in money market funds and RRP.
When most governments borrow money they do so to spend it and, certainly, I think that's more than fair to say for the US right now. And, theoretically, when the government spends money it's pushing it back into the economy, creating/stimulating economic activity. Traditionally there's also an assumed multiplier effect -- government spending ends up in consumers' pockets and then their spending/investment also creates economic activity.
But, the government doesn't create wealth or earn money, so they have to get the money they spend from somewhere -- basically either taxes or borrowing.
So, assume the government decides to spend money and raise taxes to fund it. That creates forces pulling in opposite directions -- higher taxes pulls money out of the economy (negative for growth) while more government spending is generally good for growth.
If the government decides to borrow the money then it really is a question of how they do so and whether the Fed accommodates it. Under QE it didn't matter -- the Fed was buying up Treasury securities so quickly the size of the deficit didn't really matter (at least not immediately) and rates were ultra-low.
When QE ended, this became a more complex question. If Treasury borrows using long-term bonds or Treasury Notes, then the money would most likely come out of US commercial bank deposits. Yes, it could also come from foreign entities/central banks buying Treasuries, but they've generally been net sellers of late.
And then you have an opposing forces problem again. Bank reserves are called "high-powered money" (you'll still see that term occasionally though it's less common than it was some years ago). The reason is the fractional reserve banking system creates its own multiplier effect -- a bank might take in $100 in deposits and those reserves back up $200 in loans for example. That credit then funds consumer spending, home buying, business investment, capital spending, etc, which creates wealth and more deposits and loans.
So, when Treasury borrowing drains reserves near-term, it becomes a question of whether government spending has a greater or lesser multiplier than private credit. That's a pretty complex topic and one where there's wide disagreement to say the least.
To further complicate matters, when Treasury borrows money in this way, it will also tend to push up interest rates across-the-board which depresses economic activity, particularly when there's a lot of credit in the system.
Also, note that some Treasury spending is actually tax credits -- so the money doesn't get spent unless it's pulled by private sector spending. For example, an offshore wind project with tax credits under the Inflation Reduction Act (IRA). If interest rates go up too much it's likely the project won't make sense even with tax credits, so it gets canceled. So, the effect of greater Treasury borrowing is actually to kill some of the investment they're trying to encourage.
Certainly, what I can tell you is that in the QE/QT era rising bank reserves tend to correlate with a strong stock market -- that's the regression I did in the article. The opposite is also true -- falling bank reserves is bearish for stocks.
In this case, Treasury has relied heavily -- far more than normal -- on short term funding (T-Bills) so that their borrowing ($1 trillion in some quarters) won't hit bank reserves or cause a large spike in rates. They have actually had a few auctions "tail" in recent months, meaning that demand was weak and they had to pay a higher rate than expected.
The only reason the T-Bill strategy is working is that the Fed has created a sort of "honey pot" of cash in the form of RRP the government can borrow from via money markets.
So, in the sense that some of the money in RRP is a function of government spending you could say that's fiscal stimulus. You could also say that since RRP is blocking some of the normal transmission mechanisms for tightening monetary policy in the QE/QT era, it's a form of subtle monetary stimulus.
The risk longer term is what happens when RRP is exhausted. Do we see a sudden spike in rates because it becomes more difficult for Treasury to borrow, coupled with a decline in bank reserves/tightening in credit. Or is it gradual enough to be manageable.
Does the Fed have to cut rates -- even restart QE -- because Treasury auctions get too messy for comfort? The problem here is that US Treasury securities are so important to the global financial system it really won't work to have them trading like a "meme" stock.
I don't think anyone really knows the answer to that because it's never happened before in quite this way, but I suppose we're going to find out in the next few months.
My fear is that economic trends and credit events have a nasty tendency to be non-linear -- what seems to be a gradual shift can suddenly accelerate or create a Black Swan event.