Weekly Policy Update – The Fed’s Balance Sheet and Other Support Programs
The Fed’s balance sheet reversed direction and has resumed expansion since early-February. As of the week ended March 25, the balance sheet had risen to $2.07 trillion from $1.84 trillion as of the week ended February 11 (see chart 1). The balance sheet should expand further as a result of the TALF program which amounts to about $1 trillion. The increase in purchases of agency debt ($100 billion), mortgage backed securities ($750 billion) and long-dated Treasury securities ($300 billion) are reasons for an additional $1.15 trillion increase in the size of the balance sheet. In sum, the Fed’s balance sheet is approaching a little over $4 trillion.
Excess reserves of the banking system continue to advance after a brief period during which they were declining.
The Fed has instituted various programs in response to the current crisis to stabilize financial market conditions. The Term Auction Facility is one of the programs where the bid/cover ratio has declined but it is holding at a high level which suggests there is a need to continue this program. The Primary Credit (discount window borrowing) has reduced from the peak seen in the fall of 2008 but the elevated level points to a necessity for these funds (see chart 3).
The Primary Dealer Credit Facility (see chart 4) appears to be losing its attractiveness in the past few weeks, which leads us to conclude that this program may die a natural death soon.
Has stress in credit markets reduced as result of these programs? Market spreads are down considerably from their peaks but they have yet to return to levels prior to the onset of the current crisis. The elevated 3-month Libor and Treasury bill spread (see chart 5) suggests continued credit market issues in the short end. There are similar problems in other credit markets also.
Consumer Spending in Q1 Most Likely to Show an Increase
Contrary to our earlier expectations, consumer spending in the first quarter is most likely to show an increase. The sharp upward revision of inflation adjusted consumer spending in January (+0.7% vs. +0.4% in the original report) is the main reason for this revision. Nominal consumer spending moved up 0.2% in February after a 1.0% increase in January. However, after adjusting for inflation, consumer spending fell 0.2% in February. A conservative assumption for March results in an overall increase of consumer spending in the first quarter of 2009 of roughly 0.6%-0.8%. This in turn will result in a modification of the headline GDP forecast, which we are working on as of this writing.
On a year-to-year basis, real consumer spending fell 1.37% in February, nearly matching the 1.35% year-to-year decline in January. The 1.9% decline in December appears to be the largest decline in consumer spending, so far (see chart 7).
The near term trend of consumer spending is most likely to be weak owing to the severe declines in payroll employment. Consumer saving in February was 4.2% of disposable income, down slightly from the 4.4% mark in January. The 3.1% saving rate in the fourth quarter of 2008 is the highest in nearly ten years, excluding the spikes related to tax rebates. Based on the January-February readings, the saving rate in first quarter of 2009 could surpass the fourth quarter mark.
Personal income fell 0.2% in February reflecting a 0.4% drop in wages and salaries. The personal consumption expenditure price index increased 0.35% in February, putting the year-to-year increase at 0.99%. The core personal consumption expenditure price index, which excludes food and energy, rose 0.2% in February, with year-to-year increase at 1.83%.
