Is This Why The Fed Is Raising Rates???

Authored by Chris Hamilton via Econimica blog,

As the Fed is in the midst of a rate hike cycle, it seems 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 its, 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.  Further, since the Fed bought most of these assets from large banks, these banks held much of the proceeds from these sales at the FRB (Federal Reserve Bank).  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 @ the FRB...likely creating a crisis in the process.  Conversely, if the Fed can't contain the $2.1 trillion at the FRB, and the reserves are 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 (interest on excess reserves) 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 interestingly, 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).  Since the end of QE, $800 billion previously held in excess reserves found its way into loans and/or markets!!!  Considering that much or even the majority of the excess reserves are held by foreign banks, it seems more likely the newly liberated cash would find its way into financial assets.  Even conservatively leveraged, that's an awful lot of money (not so conservatively leveraged, it's a big deal)!

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%)...but behold, excess reserves have responded by increasing almost $200 billion (chart below) since the recent set of rate hikes.

Excess reserves held at the FRB appear to have responded to the ramping IOER...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% (potentially choking real world economic activity in order to pay banks to not blow the greatest bubble of all time?!?).  That would be $64 billion annually paid to the largest (primarily foreign) banks for doing nothing, taking no risks, and lending no money.

Otherwise, as the Fed continues reinvesting its maturing balance sheet, banks will continue to pour liquidity into the real world (primarily financial assets) rather than holding the proceeds at the FRB...pushing assets further into orbit. 

With an asset bubble already of epic proportions (detailed HERE and HERE), the only means to corral the excess reserves appears to be continually raising the federal funds rate (absent impact on the long end of the curve???) and continually paying the biggest banks more IOER's not to lend money, paying the biggest banks billions more not to invest!?!

In a world where population and economic growth are slowing rapidly (detailed HERE and HERE and HERE), this appears to have been the Feds plan all along?!?


lester1 Fri, 06/30/2017 - 11:38 Permalink

The globalists at the Fed said data be damned, we're raising rates to crash the markets to fuck President Trump since nothing else seems to stop him.

gold rubeberg wet_nurse Fri, 06/30/2017 - 15:32 Permalink

It's a class that profits from tearing down national boundaries and moving government further from the consent of the governed. As you globalize, you're increasingly subject to the policies of foreign governments where you have no say at the ballot box. This weakens democracy and makes governments less accountable to their voters, increasing the power of unelected elites.

In reply to by wet_nurse

Ghordius BigCumulusClouds Fri, 06/30/2017 - 12:00 Permalink

I spent years here on ZH ranting against the use of that word. and you know what?you and I are now... wrongby now, the word is used/legit, even though it's imo still badly defined, kind of "opposite of Nationalist", at the momentsee here: (not to be confused with Globalization)and here, a magazine with this name: https://www.theglobalist.comnote, anyway, that the usage is still kind of/mostly in the US only. particularly as a negative/slur (best seen if you try out the word on Brits, which invariably tend to spontanously like all words with "global" in it)

In reply to by BigCumulusClouds

Erek Fri, 06/30/2017 - 11:38 Permalink

The FED dropped rates to zero because they don't know WTF they are doing.Now they are raising rates because they don't know WTF they are doing.But most likely it is part of a larger evil plan.

Disgruntled Goat Fri, 06/30/2017 - 11:39 Permalink

Heres another reason: They have destroyed every laddered Treasury portfolio with their reckless policies. Who heavily uses these? Insurance companies, annuities, and pension funds. 

BigCumulusClouds Fri, 06/30/2017 - 11:41 Permalink

The Fed is raising rates to bail out the commercials in their huge short positions in Ag, Au and oil. Once they cover and stocks go south, Au and Ag will take off with a major fucking QE4.

LawsofPhysics Fri, 06/30/2017 - 11:41 Permalink

Great analysis, but ALL MUTE as banks have NOT been "BANKS" since the connection between money creation and SOMETHING REAL was severed in 1971!Fuck em hambone, now jump you fuckers!

Ghordius Fri, 06/30/2017 - 11:46 Permalink

interesting articlenah, in a way, it's even simpler then that: the upside on those extreme measures vanishes, after a whileand this while the downside caused by those extreme measures starts to build updrugs often behave this way, don't they? take those years of QE as a kind of pain-killer usage, big style

Xena fobe Countrybunkererd Fri, 06/30/2017 - 12:23 Permalink

Actually they don't.  The pain killing effect does not diminish.  Our brain only develops tolerance to the chemicals that affect mood. Patients need to recognize what is going on.  The pain will continue to be relieved as effectively as ever.  Chronic pain sufferers who need opiates to function independently need never increase dosages. But if a patient is really looking for a mood altering effect, he will have to increase dosage. Opiates are not the best choice for recreational drug use for that reason.

In reply to by Countrybunkererd

Countrybunkererd Xena fobe Fri, 06/30/2017 - 12:44 Permalink

I guess I could argue for your point but still disagree as odd as that sounds.  Maybe this helps:  I was on them for years due to severe injury and there were days/weeks where more would help and days/weeks where the dose I was on was more than needed.  I support your statement that the effect doesn't diminish to an extent but the body and more so the brain does very strange things during prolonged use.The brain/body builds additional pain receptors over time due to the chemically blocked pain receptors not sending the signal to the brain.  Having been on them for a long time (Thank God I am not now!!!) I will tell you that they can and DO actually cause INCREASED pain long term.  I have the same pain now that I had when i took the meds but during the ramp down process my pain was terrible.  It is about a 6 month process for the receptors to go back to normal.  During that time without medicine normal pain is magnified greatly and if you don't have the strength to deal with it you won't get out.They are not a good choice period.  I can't imagine a weak willed person without support from family EVER getting out of their long term use.  But that is a different issue.  So yes i can agree, but it is more complicated.  And there is little information out there regarding the true nature of these death pills.

In reply to by Xena fobe

Flounder Fri, 06/30/2017 - 11:51 Permalink
Wise Woman: Very well then. Three other paths are open to you. Three cunning plans to cure thy ailment.
Blackadder: Ah, good.
Wise Woman: The first is simple - kill the market!
Blackadder: Never!
Wise Woman: Then try the second - kill yourself.
Blackadder: Hmm... And the third?
Wise Woman: The third is to ensure that no one else ever knows.
Blackadder: Ah, that sounds more like it! How?
Wise Woman: Kill everybody in the whole world!
buzzsaw99 Fri, 06/30/2017 - 11:53 Permalink

this is exactly why raising rates has zero effect.  the banks have excess reserves, meaning they don't give a flying fig what the overnight rate is because they wouldn't need to borrow even if they wanted to make loans.  the only thing raising the overnight does is hurt the little banks that rely on overnight loans due to chronic shortfalls.  thus, the fed, once again, favors the fucking tbtf over the little guy.

Yen Cross buzzsaw99 Fri, 06/30/2017 - 11:59 Permalink

 Buzz gets it. You can raise rates all you want. If you don't draw down reserves, it's meaningless. The fed should have been pulling back liquidity, and not raising rates, many years ago. Traders just sell bonds in front of the fed rate increases because they know the liquidity[free cash] is still there. Then traders pile back into bonds for protection, and use low yields for their reasonings. The cracks are starting to show, even @ 125 basis points. That's why I'm shorting credit markets.

In reply to by buzzsaw99

adr Fri, 06/30/2017 - 11:56 Permalink

What a surprise, banks that own the Fed took the printed cash and pumped stocks like Apple, Google, Facebook, Amazon, etc to the stratosphere booking billions if not trillions of dollars on their books.Why settle for a few billion in interest payments when you can make hundreds of billions pumping up this bullshit market. The Fed is responsible for $1000 AMZN, not Jeff Bezos. Funny how all the Blue Apron commercials have disappeared, just like Twitter commercials, snapchat, GoPro, etc. Commercials aren't for selling product, they're for selling worthless IPO stock. The new commercial king is Peleton. Using that VC cash to pump their valuation. It's a $2000 excercise bike. You can buy a "professional" exercise bike for $1200 that destroys the Peleton. Their bike is equivalent to a $700 bike from other companies. I guess you pay $1300 for the connected TV screen. So another bankrupt company will go public with a valuation greater than the entire industry they exist in with a product that represents less than 5% of the total market. 

nsurf9 adr Fri, 06/30/2017 - 14:40 Permalink

Thomas Jefferson was right - through booms and busts the central bankers will rob us and we will wake up wage slaves, penniless in the country they fought and died to create.   Yep, you've got it.  Dilution of the money supply and its equalization/inflation of all assets take time.  This allow bankers and their friends the advantage to play this bow-wave of the inflation as it moves into the targeted asset classes, and ultimately all classes.  Taking advantage of the bow-wage is sort of like investing at sea-level during low tide, knowing all the well that a high tide will soon move across the ocean and will soon raise all boats in the harbor.  Only, the tide doesn't go down, - until, and when, they acually "really" tighten liquidity.Until our currency completely fails, four silver 1964 quarters will likely never again be worth a $1 federal reserve note and a loaf of 1913 bread will never be 5 cents a loaf - - because these bastards have systematically diluted our money since 1913.  Oh yeah, wage inflation is normally among the last to inflate, which is why it is a primary Fed rate criteria and why our "government" has encouraged mass unchecked immigration to keep wages low.    A government taking our money's buying power after we have earned it, amounts to a taking of property without due process.  Stealing - plain out theft.  And, before the Currency Act of 1913, it was unconstitutional, unfair, and an invisible tax.

In reply to by adr

Hubbs Fri, 06/30/2017 - 12:37 Permalink

Very interesting article which I read and studied at least three times.So it appears that the FED may be raising interest rates because it wants to keep the banks cash reserves on its balance sheet instead of having them "pull them" and speculate in the stock market.It appears that despite the stock market "bubble", these banks  must perceive that owning shares of  factories and companies still is a better option than owning soon to be worthless FRNs.  The problem appears that there is now an "arms race' (no winner) where the FED digs itself deeper into debt (ability to print ad lib not withstanding, because printing is translated into inflation) to keep the banks excess reserves from fleeing.A complete decoupling of the banks, stock market, and increase in fiat (pure inflation) from the rest of the working/middle class/real world that will wind up in grinding deflation, as all this fiat will be locked up in finacial instruments and the real world economy will get starved.  By analogy, if we proceed into a Maunder minimum (another mini ice age) then all the fresh water will be locked up in the Arctic Ice and  Antarctica, and the rest of the liveable world will be starved for water.  But then again, the Globalists have been harping about global warming for years. They wouldn't be lying to us now would they?