As we get closer to any lift-off in rates by the Fed, it is good to see what the Fed has done to its balance sheet where we are before any change in rates. The Fed has gone from holding about $800 billion to $4 trillion in assets, a fivefold increase. The portfolio has not changed in the last year and it will not change even if the Fed raises rates this year. Raising the rate on reserves held at the Fed will make it more difficult to charge the lower rates to borrowers. This action will not change the balance sheet. Reverse repo may drop some of that asset number given it will be lent to Wall Street, but it will not place a large dent in the balance sheet.
There has been talk concerning what is the impact of a rate rise, but make no mistake, there will not be a change in the amount of high powered money. Excess reserves exist because banks have not found viable investments. Hence, the excess reserves are not used. If there were viable investments, loans will be made even at higher prices. Borrowers will go to the bank even if rates are 25 bps higher if the cash flows from investing are present. Raising rates may change some marginal borrowing. We have seen much corporate issuance before September in order to beat any Fed action, but the credit channel between Fed action and lending is still not working.
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