Federal Reserve surveillance: the ECB is reluctant to move
In the world of central banking, it is often a “relative” world, rather than an absolute one.
Right now, the Federal Reserve System in the United States is working overtime to convince business leaders and investors that he is seriously considering raising interest rates and reducing the securities portfolio.
More and more leaders within the Fed are now calling for rate hikes of 50 basis points instead of 25 basis points, and we have a “clarified” picture of what the Fed plans to do to reduce the size of its securities portfolio.
The plan: The Fed now intends to frame a reduction in its securities portfolio of $95 billion per month starting very soon. This reduction would include a $60 billion per month decline in US Treasury securities and $35 billion per month in mortgage-backed securities.
So the Federal Reserve seems to be working hard to convince the markets that it is going to do what it has been talking about for several months now and it looks like it is getting convincing enough to drive the markets lower.
This is not true of Europe
This is not the path the Europeans are following.
Inflation is skyrocketing in Europe.
Last month, annual inflation hit a new eurozone record high of 7.5%.
The March figure is expected to be similar or even higher.
But, the members of the European Central Bank are mixed.
The ECB has been buying bonds regularly for nearly eight years.
Negative interest rates persist.
There is a group of policymakers, however, who still argue “for a ‘wait and see’ stance due to uncertainty over the eurozone economic impact of Russia’s invasion of Ukraine.
Others are pushing for “a firm end date” on its net bond purchases “to set the stage for a third-quarter interest rate hike.” They are afraid of “falling behind” in the fight against inflation.
Thus, the ECB decided on a “balanced compromise: reduce its bond purchases more quickly and end them in the third quarter barring a sudden reversal, while postponing the decision to possibly raise interest rates”.
The fear: tightening monetary policy too soon “would amount to significantly lowering real activity and employment, knowing how to lower wages and incomes”.
We see the consequences of this policy in the relative strengthening of the US dollar against the value of the euro.
Currently, it costs around $1.0865 to buy one euro.
It was later in the spring of 2021 that Fed members really started talking about reducing their monthly securities purchases and raising their key interest rate.
On June 1, 2021, it cost around $1.2250 to buy one euro.
The ECB, at that time, would not even think of slowing down its purchases of securities or raising its interest rate.
Therefore, the value of the US dollar has strengthened from June 1, 2021 to the current date.
If the Federal Reserve does indeed accelerate the pace at which it raises its key interest rate and sticks to its timetable for reducing the size of its securities portfolio, and the ECB follows the timetable described above, the value of the dollar should continue to rise against the euro.
It will be interesting to see how long this “relative” difference in monetary policies can continue to exist.
It does show, however, that the Federal Reserve’s actions so far are having an impact on markets, globally.
Federal Reserve activity
The effective federal funds rate remained constant throughout the week at 0.33%.
The portfolio of securities held by the Fed only increased by $1.2 billion.
Reverse repurchase agreements fell $65.2 billion.
As a result, reserve balances with Federal Reserve banks increased by $76.4 billion.
However, over the past month and since the start of the year, reserve balances with Federal Reserve banks have fallen by $69.6 billion and $190.0 billion, respectively.
Reserve balances with Federal Reserve banks are a rough approximation of “excess reserves” in the banking system. So a drop in these reserve balances means the Fed has somewhat “tightened” or reduced liquidity in the banking system, which is consistent with a hike in the fed funds rate.
Thus, since the start of the year, the Federal Reserve has overseen a modest decline in bank liquidity.
Since March 2, 2022, the Fed has only added $36.0 billion to its securities portfolio.
Thus, the Federal Reserve produced results that are consistent with the decrease in outright purchases of securities.
Given that the Fed plans to oversee the decline in the securities portfolio by $95 billion per month starting in May, it looks like it is positioning itself to do just that.
Wait, the crunch is just beginning. Now let’s see if Chairman Powell and other Fed leaders are sticking to their “guns” or not.