The Case Of The Disappearing Fed Funds Market And The Reappeared Half Trillion

The Fed’s liabilities fluctuated wildly last week while total assets were little changed. The wild changes in liabilities were a direct result of the Fed actually supporting, promoting and encouraging banks to dress up their quarter end balance sheets.

What a sordid spectacle. It confused many observers into thinking that something drastic was going on in the financial system. It was actually just a Fed shell game of moving bank deposits from regular reserve deposits to the Fed’s Reverse Repo Accounts, and then back, over a couple of days between the end of the third and beginning of the fourth quarter.

There has been essentially no change in the total size of the balance sheet since QE officially ended a year ago. And there will be no material change going forward until the Fed either decides to start shedding assets (not gonna do it) or until it restarts QE (somewhat more probable than shrinking the balance sheet).

Meanwhile, loan growth in the US continues to surge. Repo loans to non banks bounced back after what looked like a breakdown. Interbank Fed Funds continue to disappear. The interbank repo market is now down to just $42 billion outstanding, down 90% from the peak level hit in 2008.

Due to the presence of massive excess reserves, the Fed will not be able to control rates through the traditional means of adding or draining small amounts of reserves in a tight reserve market. Those adjustments are reflected in the interbank Fed Funds market, which has virtually ceased to exist in the presence of so much excess cash in the system.

That was the old way. The new way is… Well, there is no new way. The Fed has made up several fantasies that it will be able to control rates through RRP and IOER interest rate increases when the need arises. We’ve addressed that elsewhere. It’s complete fantasy.