Is This Why the Fed is Raising Rates???

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by Chris Hamilton
As the Fed is in the midst of a rate hike cycle, it is important to remember why this cycle is like no previous rate hike cycle.  The mechanics of this hiking cycle are completely unique and experimental…thus the outcome is far more of an unknown than “normal”.
Why?  In a typical cycle, the Fed would sell a relatively small portion of it’s assets…er, balance sheet (typically short duration bills and notes) to banks.  This would withdraw some of banks liquid funds (replacing them with less liquid assets) and create tightness.  This tightness would push overnight lending rates higher and the daisy chain of rising rates would work its way through from the shortest eventually all the way to the 30yr Treasury bonds.
However, this time, nothing like that is happening.  This is because the Fed sold all its short term notes/bills (in Operation Twist) and bought longer duration MBS (mortgage backed securities) and longer duration Treasuries in Quantitative Easing to the tune of $4.5 trillion.  For the Fed to perform typical rate hikes, it would need to remove most of the $2.1 trillion banks are now sitting on in excess reserves…likely creating a liquidity crisis in the process.  Conversely, if the Fed can’t contain the $2.1 trillion at the FRB, and it is leveraged into the market…stand back in awe of the mother of all bubbles.
Thus, the Fed has instead determined to raise rates via paying banks interest on these excess reserves to  maintain the reserves at the Federal Reserve.  In short, pay banks not to lend money, not to invest the reserves.  This is just like Federal programs that paid farmers not to farm…IOER pays big bankers not to bank.
Since the end of QE in late 2014, the Federal Reserve has continued to buy bonds with the intent of maintaining a consistent quantity of assets on its balance sheet.  But banks excess reserves have been declining, by as much as $800 billion since late 2014 (chart below).  Apparently, during this Fed balance sheet maintenance phase (as the Fed continues to buy assets from the banks to maintain its balance sheet) banks aren’t doing their part and have been unwilling to retain these proceeds as excess reserves.

And a close up of the above chart from 2014 to present (chart below).  This has meant an extra $800 billion in liquidity finding its way into loans and/or markets!!!  Even conservatively leveraged, that’s an awful lot of money (not so conservatively leveraged, it’s a tsunami)!

Excess reserves held at the Fed declined by almost $800 billion from the end of QE until the Fed began it’s more recent set of rate hikes (from 0.5% to 1.25%)…and behold, excess reserves have responded by increasing almost $200 billion (chart below)?!?

Likewise, excess reserves appear to have responded to the ramping interest paid on excess reserves…just as the Fed intended (chart below)?

And paying those banks not to lend or invest those trillions of dollars is about to get very expensive…the 2018 number simply assumes the Fed gets all the way to 3% and what banks will be paid for doing nothing and taking no risks with that money.

Otherwise, as the Fed continues rolling over maturing to new bonds, banks will continue to pour liquidity into the real world…pushing financial assets further into orbit.  With an asset bubble grinding higher, the only means to corral the excess reserves appears to be continually raising rates and continually paying banks more not to lend money, paying banks billions more not to invest!?!  This appears to have been the plan all along?!?

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1 thought on “Is This Why the Fed is Raising Rates???

  1. Is there any doubt Yellens and the Elites want to keep the economy on life support until THEY are ready to crash it?
    .
    These Crony Corporate Fascist Pigs can’t be havin money git to the small business man and have them expand and CREATE real Jobs, can we?

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