A few weeks ago in the column, "Why the Fed Has a Credibility Problem," I discussed the increase in treasury holdings in the U.S. banking system as an indicator that the banks do not agree with the assessment for the Fed to raise rates this year. I also noted that the increase further indicates that the banks believe the Fed won't raise rates this year.
Since that column was written, the banks have filed their fourth quarter 2014 call reports, which provide data on the specific holdings of individual banks. This granularity provides better insight to what the banks are doing and it's a worth a discussion.
As of the end of fourth quarter 2014, the banking system had about $405 billion worth of U.S. treasury holdings, which equated to around 2.61% of total assets.
To put this in context, just one quarter earlier, at the end of the third quarter, the total was over $345 billion and about 2.25% of assets. That's an increase of 25% in fourth quarter alone. In quarter two, the total was $273 billion and 1.80% of assets. That's an increase of 26% in the third quarter from the second and 48% in the second half of 2014.
In the first quarter of 2014 the total was $237 billion and 1.60% of assets. That means the second quarter was 15% above the first and an increase of 70% in three quarters. At the end of 2013, the total was $193 billion and 1.3% of assets.
Throughout 2014, as the tapering process was underway, the banks increased their holdings of treasuries by 110% , which also doubled the percentage of assets dedicated to treasury holdings in one year.
To put this buildup in further context, the percentage of banking system assets invested in U.S. treasuries a decade ago was about .5%.
The increase in holdings is indicative on many things but three are most important right now.
The first, as I've discussed before, is that if the banks thought that either short-term or long-term rates were going to increase, they would be selling treasuries, not buying them.
Second, the increase in treasury purchases appears to be funded by an increase in short- term borrowing costs, which have continued to decline. The average total interest expense incurred by the banks in aggregate is now .34% annually. That's a decline of roughly 50% in the past three years.
That brings me to my third point. The banks are putting carry trades on into U.S. treasuries, making loans to the U.S. government, rather than lending the money to the private sector. And that especially includes the traditionally economically important retail / consumer borrower.
This is an indication that growth in economic activity cannot increase and warrant an increase in the Fed Funds rate this year. It is more indicative of the opposite.
A debt-funded and driven economy, which the U.S. is, requires an increase in retail and borrowing. It also needs an increase in the rate of retail borrowing in order to expand and to cause concerns about inflation so as to trump concerns about deflation.
The numbers used so far in this column are for the banking systems roughly 6,500 banks in aggregate. If we consider the largest and most politically influential, the money centers, the numbers are even more revealing.
In 2014 Wells Fargo (WFC) increased its treasury holdings from $500 million and 0.03% of assets at the beginning to $61 billion and 3.90% at the end. At Bank of America (BAC), the increase was from $6 billion and .38% of assets to $67 billion and 4.2% of assets.
At Citigroup Inc. (C) the increase was $69 billion and 5% of assets to $110 billion and 8.1% of assets. At JPMorgan Chase (JPM) the increase was from $7.5 billion and .36% of assets to $13 billion and .58% of assets.
The most interesting point is that the two most active in the retail / consumer lending space, the most important portion of which is residential mortgage lending, were Bank of America and Wells Fargo. That also is where the greatest percentage increases were.
Of the $213 billion increase in treasury holdings in 2014. these two banks alone represent $121.5 billion: more than half of the increase of all 6,500 banks.
When the Fed members say that they want to increase the Fed Funds target rate, it's not because zero interest rate policy (ZIRP) has successfully caused an increase in monetary inflation -- evidenced by an increase in the monetary base caused by an increase in lending. It is because the policy has failed to cause such activity and the cheap debt capital is ending up in the financial economy rather than the real economy.
The Fed's primary concern is not real inflation; it's that ZIRP is funding an asset bubble.