The Guest Blog

Busch: Fed's Bloated Balance Sheet

For three weeks in a row, banks have reduced their borrowing from the lending program that the Federal Reserve supplies emergency purposes. The Fed said Thursday that commercial banks averaged $30 billion in daily borrowing over the week that ended on August 27th, which is down $700 million from the previous week. This funding costs just 0.50%. 

The discount rate is the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility--the discount window.  The names of the institutions borrowing from the window are not published.

Prior to the summer of 2007, the Fed really only had two tools to influence the credit markets.  The Fed Funds rate and the discount window. Since then, the Fed has experimented with many different programs from the TAF to expanded currency swaps to quantitative easing (buying of GSE and TSY debt). Due to this activity, the Fed's balance sheet has swollen from less than $900 billion in 2007 to today's $2.1 trillion. 
However, the drop in discount window borrowing coupled with a drop in the lending for commercial paper exemplifies that credit continues to improve throughout the US economy. This highlights the looming decision the Fed will have to make on when to begin the process to unwind their easing programs.

Last night, Federal "The challenge my colleagues and I face is navigating between the risk that early removal of monetary stimulus snuffs out the recovery and the risk that protracted monetary accommodation stokes inflation expectations that could ultimately fuel unwelcome inflationary pressures." Lockhart went on to say that it's important to condition the markets to anticipate when the Fed will end the mortgage buying program. This will be discussed at the upcoming Fed meetings on September 15th and 16th.

As a matter of fact, all central banks and finance ministers will likely be discussing this topic in the lead up to the G20 finance ministers meeting in London on September 4th.  For the markets, this becomes now a game of anticipation of who will be the first to pull back from the easing and who will be the first to raise interest rates. The Bank of Israel appears to have jumped the gun when they raised rates 25 bp to 0.75%. 

However, this theme of pushing away from the monetary table to reduce a swollen belly of stimulus will be on everyone's plate going forward.


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Andrew B. Busch is Global FX Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and and you can follow him on Twitter at .