Federal Reserve Pauses Tightening as Emergency Lending Hits $300 Billion

The Federal Reserve Board building on Constitution Avenue in Washington on March 27, 2019. Brendan McDermid/Reuters

The Federal Reserve balance sheet has surged to its highest level since November as the central bank attempts to avert the contagion of the banking crisis.

The Fed’s balance sheet for the week ending March 15 increased by $297 billion, hitting a five-month high of $8.639 trillion.

Since climbing to an April peak of $8.965 trillion, the U.S. central bank has gradually reduced its balance sheet over the past 10 months by redeeming $95 billion worth of securities each month.

During the COVID-19 pandemic, the Fed had accumulated approximately $4.6 trillion worth of Treasurys, mortgage-backed securities, and corporate bonds, dramatically bolstering its bond portfolio to nearly $9 trillion. However, its latest tightening endeavor has diminished its role as a liquidity provider for the financial system, especially as money-supply growth contracted in January (negative 1.05 percent) and February (negative 1.73 percent).

The Fed’s purchases or sales of government bonds can affect the amount of money in circulation. The more it purchases, the greater the money supply grows, resulting in inflation.

But while some contend that this is a form of crisis-era quantitative easing (QE), others posit that the latest balance sheet expansion results from banks borrowing short-term loans.

Fed balance sheet figures show that financial institutions borrowed a record $152.9 billion from the central bank’s discount window, which is how it lends money to its member banks. Companies will take out overnight loans to ensure that they can meet reserve requirements by the end of the business day.

Federal Reserve Board Chairman Jerome Powell speaks during an interview by David Rubenstein, chairman of the Economic Club of Washington, at the Renaissance Hotel in Washington on Feb. 7, 2023. Julia Nikhinson/Getty Images

In addition, banks have already borrowed close to $12 billion from the new Bank Term Funding Program (BTFP). This was established in the wake of the bank failures in early March and offers liquidity for financial entities that guarantee loans with high-quality collateral, including Treasurys and mortgage-backed securities. They will be required to pay interest on these loans.

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 Corp. (FDIC) created in the aftermath.

Meanwhile, the Fed continued to offload its Treasurys and mortgage-backed securities by roughly $7 billion and $2 billion, 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, wrote 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 2. Deposits are shifting and that is causing stress.”

But Peter Schiff, the chief economist and global strategist at Euro Pacific Capital, disagreed, writing 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 said. “And looking at the bigger picture, this bailout likely means the end of the Fed’s inflation fight.”

Citi strategists assert that the “new BTFP facility is QE in another name” since assets will jump on the balance sheet and boost reserves.

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

‘Uncertainty Around the Fed Path’

Economists say the real test of its inflation-fighting tightening campaign will happen on March 21 and 22 when the Federal Open Market Committee (FOMC) convenes for its monetary policy meeting.

Goldman Sachs economists recently changed their expectations for the crucial meeting and now anticipate a pause in rate hikes. The bank’s forecasts for the other upcoming meetings were unchanged, and it’s penciling in a peak benchmark fed funds rate of 5.25 percent to 5.50 percent, but there is “increased uncertainty around the Fed path from here.”

According to the CME FedWatch Tool, the market is mostly penciling in a quarter-point increase, which would boost the target rate range to 4.50 percent to 4.75 percent.

Chair Jerome Powell and other rate-setting committee members will have two main choices when choosing how to manage the bank failures and maintain its inflation fight, according to Judith Raneri, the 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 said in a note.

How this will affect recession odds is unclear, “but we know that with bank failures come credit contraction,” Nancy Tengler, the CEO and Chief Investment Officer of Laffer Tengler Investments, wrote.

“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. That will slow small business who have been doing a great deal of the hiring.”

Over the past year, the FOMC has raised the policy rate by 450 basis points.