Two weeks ago, the Federal Reserve expanded its balance sheet to mitigate potential liquidity issues within the US banking sector. Data suggests that the probability of risks in US banks transforming into systemic risks is relatively low. The Fed’s balance sheet expansion will unlikely to increase the money supply or exacerbate inflationary pressures. While bankruptcy risks for small and medium-sized US banks may persist, these are primarily isolated incidents. Thus, the likelihood of systemic financial risks in the US has been significantly reduced.
How Does This Affect US Stocks?
Suppose systemic financial risks in the US do not materialize and the Fed initiates interest rate cuts in the second half of this year. In that case, US stocks will likely benefit. Decreasing interest rates will potentially increase valuations for US stocks, especially within the technology sector.
The following provides a detailed analysis of the Fed’s passive balance sheet expansion.
Passive Expansion, Not a QE Restart
The recent expansion of the Fed’s balance sheet has garnered market attention. Total assets increased by nearly $400 billion over the past two weeks. The asset increase is primarily attributed to the utilization of liquidity and credit instruments. These tools can provide short-term, temporary liquidity support in response to recent bank risks. However, this passive expansion is temporary and should not be confused with a restart of the Fed’s Quantitative Easing (QE) program, which involves active and continuous expansion. The Fed currently maintains its Quantitative Tightening (QT) plan, and it does not conflict with temporary liquidity support for financial stability.
Over the past two weeks, liquidity and credit instruments have collectively increased by $339 billion (approximately $300 billion the previous week). Within this increase, the discount window has risen by $110 billion (decreasing by $42.6 billion last week, with a maximum term of 90 days). BTFP has grown by $53.7 billion (with $41.7 billion last week, a maximum term of one year). And FDIC (bridge loans for the rescue of Silicon Valley and Signature Bank) has expanded by $179.8 billion. Overall, liquidity constraints within banks have eased compared to the last week.
In a surprising development, FIMA tools recorded $60 billion in usage this week. Established in July 2021, FIMA primarily offers liquidity to foreign central banks or international monetary authorities (with US Treasuries as collateral). Given the overseas holdings of US Treasuries, a limited number of economies (approximately 20) hold a minimum of $60 billion. The use of FIMA may be related to its more discreet nature compared to lower-cost central bank liquidity swaps, which disclose counterparty details daily, while FIMA only discloses usage amounts. In conclusion, non-US liquidity is relatively constrained, with FIMA users likely to come from Europe.
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