Update Of Liquidity Cycle

Back on 12/12/16, I posted an upbeat view of monetary policy and the liquidity cycle.  liquidity
It is appropriate to update this document now. Two series I watch to gauge the amount of primary
system liquidity that are provided by the Fed are Fed Bank Credit (the Fed's balance sheet) and
the monetary base. With the end quantitative easing as 2014 closed out the Fed froze these two
series. I believe this closing of the liquidity spigot played a role in slowing down the US economy
and the stock market over the past two years. The US stayed out of recession mainly because of
the more than adequate growth of private sector funding. However, as part of its efforts to raise
short term interest since late 2015, the Fed has constricted the growth of its balance sheet by nearly
$50 billion and the monetary base by nearly $400 billion. During the Fed's QE programs,  the
banking sector saw its excess reserves skyrocket. The reductions in primary liquidity over the
past year lead to a draw in these reserves.  Excess Reserves


The size of the reductions in primary liquidity are unprecedentedly large and would normally be
considered as catastrophic for the economy and the financial markets because of the withdrawal of
liquidity. The Fed is apparently not troubled as the reserves are way in excess of  what banks are
required to hold. Still the Fed is withdrawing liquidity so it is incumbent on analysts to monitor
this situation going forward for possible system wide effects such as development of an undertow
for the economic expansion. Important as well is that the Fed may not feel constrained to add to
its balance sheet if it sees this step as necessary to keep the expansion intact.