Fed’s Balance Sheet May Be Too Small by at Least $1t: Cumberland
(Bloomberg) -- Fed’s balance sheet should be ~$5.5t, or $1t bigger than its current size, given global demand for physical cash, liquidity coverage ratio (LCR) requirements and foreign bank demand, Cumberland CIO David Kotok writes in note.
- NOTE: Fed’s balance sheet $4.461t as of June 1
- “If reserve assets are scarce, then the prices of substitutes should be bid up, and rates should fall,” as evidenced by the shift in yield curves
- NOTE: U.S. 2/10 curve touched 89.2bp, flattest since Nov. 2007
- Cumberland est. says ~$1.5t needed to meet demand for physical cash; ~$1.5t needed to meet demands of foreign banks and cash pools, a number that’s growing every year; ~$2t needed to meet liquidity coverage ratio (LCR) requirements for U.S. banks by Jan. 2017
- Fed needs to provide Treasury with ~$300b-$400b annually, though “there has been no growth since QE stopped”
- U.S. dollars may be growing scarce, given the widening spreads in the euro/dollar term structure
- Flows into dollars aren’t symmetrical between dollar and euro, which means demand is rising for dollars to be held at the Fed
- Flows likely to grow, as is demand, as they figure into the LCR calculation for both foreign and U.S. banks
- Dollars at the Fed aren’t “truly excess reserves” but function like required reserves because of LCR
- If Fed doesn’t provide enough of those dollars, “the prices of other assets change in response,” as seen in the 2Y yield curves
- Fed can set IOER, size of balance sheet separately, though “how it does so and what assets it acquires are the important issues”
- Unknown is what happens if Fed “ignores the essential role that ‘excess reserves’ play”
- Additional asset purchases will also flatten curves, though “it will at least provide the world with the dollars it seeks in order to meet LCR”
- If the Fed raises IOER to 75bps, then the spread widens more and curve flattens more
- Fed needs to increases volume of “scarce LCR-qualified resource” every time it raises IOER
Alert:
HALISTER1Source: BFW (Bloomberg First Word)
People David Kotok (Cumberland Advisors Inc)
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