Friday, February 15, 2008

LIQUIDITY WATCH. ACROSS-THE-BOARD DECLINES!
. Federal Reserve: "Factors Affecting Reserve Balances", February 13

- Fed's Treasuries holdings: $75530bn (-$2.2bn)
- Other central banks' Treasuries holdings: $1,266.7bn (-$0.5bn) (*)
- Other central banks' agency securities: $846.2 (-$4.2bn) (*)
- Global Dollar Liquidity Measure: $2,822.0bn (-$6.9bn)

(*) Off-balance-sheet items
agustin_mackinlay@yahoo.com
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The weekly Fed balance sheet shows modest, but across-the-board declines. All components of the Global Dollar Liquidity measure are down: the Fed's own stock of Treasury securities, foreign central banks holdings of Treasuries, and foreign central banks holdings of agency securities. This is a very rare occurrence indeed! Most striking of all, the "domestic" (*) component is now down for two months in a row. The last time we had back-to-back contractions in this proxy of the monetary base was in ... December 2000/January 2001!

(*) Strictly speaking, the adjective "domestic" is a bit of a misnomer here. The Fed destroys liquidity whenever it defends a target for the fed funds rate that is too high relative to the demand for bank reserves. The weakness in the demand for bank reserves, in turn, may reflect both domestic and international factors.

5 comments:

Economics Student said...

Are there any significant factors in the world now depressing the UST yields and demand of bank reserves?

A thousand thanks!

Agustin said...

Banks have recourse to the inter-bank market in order to finance the loans they make in ... the credit market. If long-bond yields decline, it makes sense to think that demand for credit --and, by extension, demand for bank reserves-- is slowing down. In other words, the private sector invests less as the economy weakens.

Note that other factors can cause bond yields to move: inflation expectations, demand for credit from the public sector (budget deficits), global savings flows, etc.

economics students said...

Thank you for answering my question!

Sorry if i sound too obvious....

But are you saying that: even if the Fed lowered the rate target, it does not mean they are easing. They only ease if they are defending a target which is lower relative to the demand of bank reserve.

So, the Fed is not adding much liquidity into the system right now?

Kate

Anonymous said...

Absolutely stunning graph from the Fed itself on page 16:

http://www.ny.frb.org/markets/omo/omo2007.pdf

We are in a new game now.

Agustin said...

Kate: you've hit the nail on the head. For more on the relationship between liquidity and the shape of the yield curve, read this 2000 Greenspan speech. [http://www.federalreserve.gov/boarddocs/speeches/2000/20000405.htm]. This is the key part (note that he is describing the situation of a very steep yield curve): "As our experience over the past century and more attests, such surges in prospective investment profitability carry with them consequences for interest rates, which ultimately are part of the process that balances saving and investment in a noninflationary economy. In these circumstances, rising credit demand is almost always reflected in an increase in corporate borrowing costs and that has, indeed, been our recent experience, especially in longer-dated debt issues. Real interest rates on corporate bonds have risen more than a percentage point in the past couple of years. Home mortgage rates have risen comparably. The Federal Reserve has responded in a similar manner, by gradually raising the federal funds rate over the past year. Certainly, to have done otherwise--to have held the federal funds rate at last year's level even as credit demands and market interest rates rose--would have required an inappropriately inflationary expansion of liquidity. It is difficult to imagine product price levels remaining tame over the longer haul had there been such an expansion of liquidity. In the event, of course, inflation has remained largely contained".

Anonymous: thanks for the very useful info!!!