Federal Reserve Pauses Tightening as Emergency Lending Hits $300 Billion

New data shows that the Federal Reserve balance sheets have risen to their highest level since November, as the central bank attempts prevent the spread of the banking crisis.

The Fed’s balance sheets for the week ended March 15th increased by $297 billion to $8.639 trillion, a five-month record.

The U.S. central banking has been gradually reducing its balance sheet since reaching an April peak of $8.965 billion by redeeming $95 million worth of securities every month.

The Fed had nearly $9 trillion of bonds and Treasurys during the COVID-19 crisis. This boosted its bond portfolio by almost $4.6 trillion. The Fed’s recent tightening has weakened its position as a liquidity provider for financial systems, particularly since money-supply growth declined for two consecutive month in January (negative 1.05%) and February (1.73 percent).

The Fed’s ability to buy or sell government bonds can have an impact on the money supply. Inflation is a result of the Fed buying more money.

Some argue that this is a form crisis-era quantitative ease, while others believe that banks are borrowing short-term loans to expand their balance sheets.

The Fed’s balance sheet data shows that financial institutions borrowed record $152.9 trillion from the central bank’s discounted window. This is where it lends money its member banks. To ensure they meet their reserve requirements by the close of each business day, companies will seek overnight loans.

Banks have also borrowed nearly $12 billion through the Bank Term Financing Program (BTFP), which was recently launched. This program, which was launched in the wake of last Wednesday’s bank failures, provides liquidity for financial institutions that guarantee loans with high quality collateral including Treasurys and mortgagebacked securities. These entities will have to pay interest.

The Fed lent nearly $143 billion to the new bridge banks—Signature Bridge Bank, N.A., and Silicon Valley Bridge Bank, N.A.—that the Federal Deposit Insurance Corporation (FDIC) launched in the aftermath.

The Fed was able to continue offloading its Treasurys, mortgage-backed securities, and Treasurys by about $7 billion and $2 million, respectively.

“The increase in the fed balance sheet is a temporary reflection of the runs on the various weak banks,” Andy Constan, the manager of macroeconomic research firm Damped Spring Advisors, posted on Twitter.

“1. The FDIC will advance a plan within the next two weeks [probably] sooner to insure more deposits. That will slow the run,” He added. “2. Deposits are shifting and that is causing stress.”

Peter Schiff, chief economist and global strategist for Euro Pacific Capital, disagrees. He wrote that “the Fed will print money out of thin air to loan to banks.”

“Even if it’s only temporary, the loans will inflate the money supply. That is the definition of inflation,” He stated. “And looking at the bigger picture, this bailout likely means the end of the Fed’s inflation fight.”

Citi strategists state that “new BTFP facility is QE in another name” Since assets will increase on the balance sheet and boost reserve.

“Although technically they are not buying securities, reserves will grow,” In a research note, Jabaz Mathai and Jason Williams, Citi strategists, wrote.

‘Uncertainty Around the Fed Path’

Economists believe the true test of the Federal Open Market Committee’s inflation-fighting tightening campaign is next week, when it convenes for its two day monetary policy meeting.

Goldman Sachs economists changed their expectations about the key meeting to anticipate a pause for rate hikes. The bank has not changed its forecasts for other meetings and now expects a peak benchmark fed funds interest rate of 5.25 percent to 5.50%. “increased uncertainty around the Fed path from here.”

CME FedWatch Tool indicates that most market participants are estimating a quarter point increase in the target rate to raise it to 4.50 percent or 4.75 percent.

Chair Jerome Powell, along with other members of the rate-setting Committee, will have two options when it comes to managing bank failures and maintaining its inflation fight. This is according to Judith Raneri (portfolio manager and vice president at Gabelli Funds).

“They can stay the course focused on price stability, continuing to hike rates despite the risk that it could add more tension to the banking sector, or they can hold for now to give the financial system some time to stabilize, even if it comes at the risk of keeping inflation hot,” Raneri stated this in a note.

It is not clear how this will affect the chances of a recession. “but we know that with bank failures come credit contraction,” Nancy Tengler, CEO and CIO at Laffer Tengler Investments, notes.

“We have already seen banks tightening lending standards and now they are likely to pull back on making credit available even further if history is any guide,” She wrote. “That will slow small business who have been doing a great deal of the hiring.”

The FOMC raised the policy interest rate by 450 basis points in the last year.