Powell's Excess Reserve Change and Gold
Commodities / Gold and Silver 2018 Jun 15, 2018 - 03:21 AM GMT
Why a seemingly run-of-the-mill announcement yesterday by Fed chairman Powell might signal a major turning point for the gold market. . . and perhaps ALL markets.
At the end of Fed chairman Jerome Powell’s opening statement for his press conference yesterday he dropped a major surprise on the markets that immediately sent the dollar and stocks tumbling and gold, silver and bonds vaulting higher. All the markets mentioned experienced sudden sharp reversals at the time of the “surprise.” Those trends have carried over to today’s market action.
To understand what caused such a strong reaction in the markets you have to go all the way back to 2009, the credit crisis and the launch of the quantitative easing program. That bail out of the commercial banks pushed more than $4 trillion of printing press money into the U.S. and global economy through Federal Reserve purchases of U.S. Treasuries and mortgage-backed securities. Those purchases left the commercial banks with a boatload of cash and the Federal Reserve with its largest balance sheet procurement in history. At the time, the standard analysis had been that the newly placed cash would migrate to the economy in the forms of commercial and consumer loans, push-up the money supply dramatically and launch a virulent inflation.
It never happened and here’s why:
Instead of leaving those reserves at the commercial banks, the Fed encouraged the commercial banks to redeposit that bailout capital at the central bank as what it called “excess reserves.” Up until Mr. Powell’s low-key reference to excess reserves at yesterday’s news conference, few people had ever heard of this little-known Federal Reserve balance sheet item, yet it consists of almost $1.9 trillion at present and peaked in 2014 at almost $2.7 trillion, and a large percentage of the original bail out. The Fed incentivized commercial banks to maintain those deposits by paying a rate of interest slightly higher than the Federal Funds rate, an advantage it kept in intact from 2009 until yesterday. To make a long and rather complicated story short, the “excess reserves” program in effect sterilized the bailout and kept it from igniting inflation.
All of that though may have changed with Mr. Powell’s low-key announcement yesterday, that the Federal Reserve would move the excess reserve deposit rate at a par with the fed funds rate – a policy that removes the long-standing rate advantage on excess reserves and, in effect, formally signals a deliberate desterilization process. That is why the Fed chairman’s seemingly innocuous statement yesterday caused such an immediate stir. What he signaled is that the Federal Reserve is now interested in incentivizing the banks to take that capital back onto their own balance sheets as reserves so that they can be leveraged and loaned into the economy. (Please see today’s Quote of the Day immediately below.)
The market reaction was immediate. The announcement was made about 35 minutes into the press conference (See chart below). Gold immediately headed north and the dollar south. Stocks plummeted and the yield on the 10-year Treasury, which had advanced sharply to over the 3% mark before the press conference, promptly dropped to 2.97%. It has dropped another 0.027% this morning to 2.95%.
Obviously, a healthy number of market participants share our view that the Fed is interested in stimulating the money supply and inflation, or in the very least, interested in letting the markets know it will stay out of the way should both begin to increase. That message was received loud and clear, though it might take some time for the impact to be completely understood and priced into various markets.
As it stands, the Federal Reserve will indeed hold back the rate on excess reserves by five basis points – raising it by 0.2% – and push up the Fed funds rate by 0.25%. Though not a monumental juggling of the numbers, it is the message, as outlined above, that the Fed is trying to send to the markets that is important. In the end, it is not a very glamorous incentive for the gold market to move higher, but it is an strong incentive nevertheless.
We believe that in future years we might look back at yesterday’s events as an important turning point for the gold market. Yesterday gold pushed back to the $1300 level almost immediately and it is up another $8 and firmly above the $1300 level at $1307.50 as this report is written. Silver has had an even stronger reaction moving up 1.3% yesterday and up another nearly 30¢ this morning at $17.30
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Quote of the Day
“Banks in the United States have the potential to increase liquidity suddenly and significantly – from $12 trillion to $36 trillion in currency and easily accessed deposits—and could thereby cause sudden inflation. This is possible because the nation’s fractional banking system allows banks to convert excess reserves held at the Federal Reserve into bank loans at about a 10-to-1 ratio. Banks might engage in such conversion if they believe other banks are about to do so, in a manner similar to a bank run that generates a self-fulfilling prophecy. . . What potentially matters about high excess reserves is that they provide a means by which decisions made by banks – not those made by the monetary authority, the Federal Reserve System – could increase inflation-inducing liquidity dramatically and quickly.” – Christopher Phelan, economist, Minneapolis Federal Reserve
Chart of the Day
Chart note: As outlined above, the Federal Reserve encouraged commercial banks to keep excess reserves on deposit at the central bank for a number of years by paying a rate higher than the federal funds rate. As of yesterday, those two rates are now at a par at 1.95%. Chairman Jerome Powell announced that the Federal Reserve will hold back the rate on excess reserves by five basis points – raising it by 0.2% – and push up the Fed funds rate by 0.25%. Though not a monumental juggling of the numbers, it is the message that the Fed is trying to send to the markets that is important. The two lines in the chart above have now converged.
By Michael J. Kosares
Michael J. Kosares , founder and president
USAGOLD - Centennial Precious Metals, Denver
Michael J. Kosares is the founder of USAGOLD and the author of "The ABCs of Gold Investing - How To Protect and Build Your Wealth With Gold." He has over forty years experience in the physical gold business. He is also the editor of Review & Outlook, the firm's newsletter which is offered free of charge and specializes in issues and opinion of importance to owners of gold coins and bullion. If you would like to register for an e-mail alert when the next issue is published, please visit this link.
Disclaimer: Opinions expressed in commentary e do not constitute an offer to buy or sell, or the solicitation of an offer to buy or sell any precious metals product, nor should they be viewed in any way as investment advice or advice to buy, sell or hold. Centennial Precious Metals, Inc. recommends the purchase of physical precious metals for asset preservation purposes, not speculation. Utilization of these opinions for speculative purposes is neither suggested nor advised. Commentary is strictly for educational purposes, and as such USAGOLD - Centennial Precious Metals does not warrant or guarantee the accuracy, timeliness or completeness of the information found here.
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