Bank Lending and Fed Balance Updates
(April 15, 2011)
Dear Subscribers and Readers,
Based on the amount of ABS and CMBS originations on a YTD basis, the liquidity situation in the global “shadow banking system” remains very challenging—and thus the Fed and the commercial banks would still need to play a big role in reviving bank lending and economic growth. Over the intermediate to long run, bank lending needs to revive for a sustained uptrend in asset prices and economic growth. Following is a monthly chart showing the state of U.S. bank lending—i.e. the year-over-year change in loans and leases by held by U.S. commercial banks for the period January 1949 to March 2011 (updated to March 30, 2011):
While the decline in bank lending in 2009 was unprecedented (unless one cites data from the Great Depression—when one-third of all US banks failed), it has steadied in the last 12 months. While bank-lending growth has risen to the zero line, however, we are not out of the woods. In fact, the absolute amount of bank loans and leases outstanding (seasonally adjusted) actually declined by $106.1 billion (to $6.69 trillion) from the end of September 2010 to March 30, 2011. Again, the lack of liquidity creation within the U.S. commercial (and shadow) banking system does not bode well for the short-term outlook for the stock market. In fact, we believe the market is likely to correct soon, if it hasn't already started.
Let's now shift to a discussion on the size of the Federal Reserve's balance sheet. Despite the latest rise in commodity prices and the ECRI Future Inflation Gauge, there is no doubt that the Federal Reserve will continue its “QE2” policy of purchasing an additional net $600 billion of Treasuries as discussed in its November 3, 2010 press release. From late June to mid-November last year, the size of the Fed's balance sheet (the amount of securities outstanding) remained steady in the $2.04 to $2.07 trillion range. Since the implementation of the Fed's “QE2” easing policy in mid-November, securities outstanding on the Fed's balance sheet has rocketed higher by $367 billion as of April 6, 2011—a record high. As shown on the following charts, the Fed had been purchasing more Treasuries as its agency debt and agency MBS holdings matured over the last nine months:
Note that any further spike in oil prices would be viewed by the Federal Reserve as one-time “see-through” events, they will be viewed as merely short-term supply constraint problems—as opposed to any structural pressure on US inflation. Furthermore, the Fed's view on global inflation or inflation in emerging market countries is, for now, one that of the bystander. That is, it doesn't make much sense for the Fed to tighten given that real interest rates in emerging market countries are still in negative territory for the most part, and the Fed's dual mandate of maintaining employment and price stability. Make no mistake: I don't believe the Fed will implement a “QE3” policy—but it is highly likely that the Fed will see through its QE2 policy and simply let it expire at the end of June.
Let's now look at the Fed's weekly purchases up to April 6, 2011:
Since mid-November, the Fed has purchased a net $17 billion of securities every week. While the amount of agency securities (which includes debt + MBS) outstanding has declined by $131 billion, this has been more than offset by $498 billion in Treasuries purchases over the same period. More important, the size of the Fed's balance sheet has rocketed higher by nearly $367 billion in the last five months—to a whopping $2.42 trillion. A follow-through to a net $600 billion in security purchases would mean an additional $250 billion in purchases over the next ten weeks—a weekly average of $25 billion. While this is a step-up relative to the $17 billion in net weekly purchases over the last five months, I believe this will do little to global liquidity, unless the Fed announces more purchases down the road. Subscribers please stay tuned.
Henry To, CFA, CAIA