Fed Balance Sheet Watching: Part II
Setup
Fed Balance Sheet: the Liabilities Side
The Federal Reserve’s (the Fed) balance sheet has gotten a lot of attention recently. In addition to interest rate targeting via the Federal Funds Rate, the Fed can affect overall financial liquidity through it’s balance sheet. In this article, we will focus on just the Liabilities side of the Fed balance sheet and how it leads to easing or tightening financial conditions through adding or subtracting liquidity (last time, in Part 1, we looked at the Assets side of the balance sheet).
Note, this article is not a deep dive into the plumbing that underlies Fed financial transactions. Anyone interested in that level of analysis should check out The Fed Guy blog by former Fed trader Joseph Wang or his numerous appearances on the Forward Guidance podcast with Jack Farley. This article is an attempt to visualize and make concrete changes in the liabilities side of the Fed balance sheet, so we can track the end result of Fed actions.
As an initial, primary source matter, where should we turn to find out about the Fed’s balance sheet? Luckily, the Fed publishes a weekly update about that every Thursday, in Factors Affecting Reserve Balances Table H.4.1 and FRED also publishes that data here. We have a scraper for mining that FRED link for every relevant code but for today we are just looking at a few time series. Let’s get to it.
Assets, of course, comprise only one side of the Fed balance sheet. We also need to examine liabilities.
Let’s start with a chart of liabilities over time, and confirm this mirrors our assets chart.
What are the largest liabilities on the Fed balance sheet? Let’s scrape FRED and display the answer:
| Fed Liabilities | |
| Level (Trillions) | |
|---|---|
| Deposits | $3.79 |
| Reverse repurchase agreements | $2.50 |
| Federal Reserve Notes, net of F.R. Bank holdings | $2.25 |
| U.S. Treasury, General Account | $0.53 |
| Other | $0.19 |
| Treasury contributions to credit facilities | $0.02 |
| Foreign official | $0.01 |
| Deferred availability cash items | $0.00 |
| Term deposits held by depository institutions | $0.00 |
| Other Liabilities and Accrued Dividends | −$0.00 |
Some form of deposits, reverse repurchase agreements (RRP) and Federal Reserve Notes (what we call dollar bills) account for most Fed liabilities. Recall when we noted that QE converts Treasury securities into Deposits (in our article on Assets), that can then be used on goods and services. When the Fed “buys” Treasuries and adds to its Assets, it doesn’t send a check to the sellers, it adds dollars to their Deposits account. In that sense, Deposits are showing us liquidity adding in the financial system.
Let’s focus on “Reverse repurchase agreements” – sometimes called “Reverse Repo” or “RRP” – because it is showing us the opposite. Dollars in the RRP are not liquidity in the financial system.
Here is a look at the RRP account and the Deposits account over time.
RRP has become a very large and important account in the last 10 years, growing from $250 billion in 2014 to around $2.5 trillion today.
Mechanically, “A reverse repurchase agreement…is a transaction in which the Desk sells a security..with an agreement to repurchase that same security at a specified price at a specific time…[t]he difference between the sale price and the repurchase price… implies a rate of interest….[this] reduces bank reserve liabilities…and increases RRP liabilities”.[^2]
As the quote says, there is an implied interest rate paid on RRP, and this rate tracks the Fed Funds Rate.
The quote also tells us that when an RRP transaction settles, RRP increases and Deposits decrease, and vice versa.
Let’s chart the weekly change in those two accounts and make sure we can reproduce those mechanics.
Just as we did with Assets, let’s take a look at the weekly flow of dollars to the RRP and notate whether the move tightens or eases conditions. Remember, when RRP increases, it is tightening, so we color positive changes as red.
Let’s also look at the monthly flow in and out of the RRP.
When the RRP is going up, financial institutions are parking money in the RRP and earning yield from the Fed, instead of putting dollars into the financial system. When the Fed raises the rates it pays on the RRP, not only does it raise interest rates, it incentivizes more institutions to make use of the the RRP. Red bars go up, liquidity decreases.
Lastly, that’s all for today Fed data watchers and visualizers! If you liked this content, please connect or follow me on linkedin and look out for our macro data science book coming out soon (chock full of R and Python code)!
Written by Jonathan Regenstein
- Executive Director Research and Analytics : Sylvan Road Capital LLC
- Research Affiliate : Georgia Tech Financial Services Innovation Lab
