The Debt Ceiling Has Been Raised – Be Afraid?
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There is an economist in Chicago who has been known to see a silver lining behind every cloud. For example, after some natural disaster that resulted in hundreds of millions of dollars of damage to structures, this economist had been known to say that on the bright side, think of the rebuilding activity that will take place. By this logic, if the federal government wanted to increase the pace of economic activity, it could call on the US Air Force to carpet bomb some selected suburb, giving the residents plenty of notice to vacate the their premises with their irreplaceable possessions. (You might want to Google Bastiat’s “broken window fallacy” for the nonsense of this). I bring this up because after the debt-ceiling increase/extension legislation was signed into law on June 3, 2023, analysts, who unlike the aforementioned Chicago economist, see a cloud behind every silver lining. Even before the debt-ceiling bill hit the desk of President Biden, these nattering nabobs of negativity (you youngsters can Google this phrase) were saying that the rebuilding of Treasury balances at the Fed would suck liquidity out of the financial system, which, in turn, would cause all sorts of unspecified problems in the financial markets.
All else the same, it is true that an increase in Treasury deposits at the Fed would drain reserves from the banking system. But all else has not been the same in this case. Let’s go to Chart 1. Plotted in Chart 1 are the four-week billions of dollars changes in reserve balances held at the Fed by depository institutions (the blue bars), Treasury deposits at the Fed (the red line) and reverse repurchase agreements (RRPs) with the Fed (the green line). The last data points plotted are for the week ended June 28, 2023. In the four weeks ended June 28, Treasury deposits at the Fed increased by $360 billion, which, all else the same, would have drained that amount of reserves from the banking system. Yet, in the four weeks ended June 28, reserves at the Fed contracted by only $29 billion (the last blue bar plotted). Evidently, all else was not the same. One major factor that was not the same was the amount of RRPs executed with the Fed. An increase in RRPs drains reserves from the banking system; a decrease in RRPs adds reserves. In the four weeks ended June 28, RRPs executed with the Fed declined by $344 billion, which offset all but $16 billion of the reserves drained via the increase in Treasury balances at the Fed.
Chart 1
Why did RRPs executed with the Fed decline in the four weeks ended June 28? One reason is that after the debt-ceiling legislation was signed into law, the fear of a Treasury default on its interest/and or principal payments vanished for the foreseeable future. Money market funds, which had eschewed Treasury bills and short-maturity Treasury coupon securities because of the risk of a Treasury default, were loading up on RRPs with the Fed, which paid an overnight rate of 5.05%. After the debt ceiling legislation was signed into law and the immediate fear of a Treasury default went away, money market funds starting unwinding their RRPs, substituting short-maturity Treasury securities that had a higher yield than the 5.05% on RRPs.
If there is something you want to be afraid of, it is not the increase in Treasury deposits at the Fed, but rather the communication from the Fed that it is likely to hike the federal funds rate another 50 basis points before year end despite that real personal consumption expenditures have increased an annualized 0.7% and that the PCE Price Index has increased an annualized 2.45% in the three months ended May 2023 (see Chart 2). The Fed seems hell-bent on driving the US economy into a recession even though the rate of consumer inflation has slowed dramatically since 2022 and is approaching its sacrosanct target of 2% annualized.
Chart 2
Now, on a personal note. Eighteen years ago today my friend, colleague and teacher, Robert D. Laurent, passed away. My hope for AI is that some day I will be able to bounce ideas of Bob again. If you want to benefit from Bob’s wisdom, Google “The Fed in Print” and go to the articles/working papers Bob wrote when he was at the Chicago Fed. Rest in peace, Bob, and your memory is a blessing to me.
Paul L. Kasriel
AuthorMore in Author Profile »Mr. Kasriel is founder of Econtrarian, LLC, an economic-analysis consulting firm. Paul’s economic commentaries can be read on his blog, The Econtrarian. After 25 years of employment at The Northern Trust Company of Chicago, Paul retired from the chief economist position at the end of April 2012. Prior to joining The Northern Trust Company in August 1986, Paul was on the official staff of the Federal Reserve Bank of Chicago in the economic research department. Paul is a recipient of the annual Lawrence R. Klein award for the most accurate economic forecast over a four-year period among the approximately 50 participants in the Blue Chip Economic Indicators forecast survey. In January 2009, both The Wall Street Journal and Forbes cited Paul as one of the few economists who identified early on the formation of the housing bubble and the economic and financial market havoc that would ensue after the bubble inevitably burst. Under Paul’s leadership, The Northern Trust’s economic website was ranked in the top ten “most interesting” by The Wall Street Journal. Paul is the co-author of a book entitled Seven Indicators That Move Markets (McGraw-Hill, 2002). Paul resides on the beautiful peninsula of Door County, Wisconsin where he sails his salty 1967 Pearson Commander 26, sings in a community choir and struggles to learn how to play the bass guitar (actually the bass ukulele). Paul can be contacted by email at econtrarian@gmail.com or by telephone at 1-920-559-0375.