Fed Cuts Rates and Quantitative Easing Coming

On Wednesday the Fed cut the federal discount rate .25 percent. However, experts believe quantitative easing is next.

Excess reserve of US depository institutions peaked almost five years ago at $2.7 trillion, and declined to $1.5 trillion currently, in line with the Fed's balance sheet shrinkage.  The banking industry requires $700 million in excess reserve, which leaves $800 million in excess reserves. However, there has been a build up of $500 million in banknotes in circulation since 2014. This reduces bank reserves. There has also been a build up of $300 million of cash by the Treasury to finance the deficit, at the expense of reserves. 

Assets of the US banking system have been growing at 4% a year which requires more reserves. Banking reserve balances divided by assets recently fell below 9%, similar level at the end of 2009. The liquidity is the tightest in a decade. The federal deficit has spiked to $1 trillion. Banks buy treasuries by borrowing in the overnight market. The jump in Treasury issuance caused an increase in demand for short-term financing.  Mark Cabana, an analyst with B of A, believes the deficit funding requirement will eventually require the Fed to bring back quantitative easing.  Because of corporate tax payments due in September, and the deficit, many bank experts believe the Fed will have to bring back QE to increase banking reserves.  For the first time since October 2014, the Federal Reserve bought a significant number of US Treasury's.  Over the past two weeks, the Fed purchased $14 billion in US bonds.  Partly due to a large cash withdraw by Saudi Arabia, to finance repairs, after an oil infrastructure attack, over night repo rates surged as high as 8.5% on Monday, September 16.  The New York Fed trading desk had to inject liquidity buy buying $53 billion worth of securities in the repo market. Banking strategist Krishna Guha, believes the Fed will shortly start growing its balance sheet by $14 a month. Mark Cabana, of B of A, believes the Fed will be forced to announce a new QE program as soon a the last quarter of 2019. Bond King Jeffrey Gundlach believes the spike in overnight repurchase agreements may prompt the Fed to expand its balance sheet. 

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