The Days Ahead:

  • First Fed meeting of the year and 101 companies report earnings.

This Week:

  • Foreign born workers are around 19% of the workforce.
  • It’s a rapidly growing group and means the labor force is growing.
  • It should mean less wage pressure.
  • QT is quietly going on.
  • But President Lorie Logan of the Dallas Fed says it’s a problem.
  • Bank reserves may be less robust than they appear.
  • The Fed may end QT sooner than expected.

Foreign-Born Labor Force

The Fed watches the unemployment rate closely, which is currently at 3.7%. It’s been below 4.0% since January 2022. The last time it had a run of two years under 4.0% was from 1968 to 1970, and inflation grew from 3.8% to 6.0%. If the labor market is too tight, employers compete for workers and wages rise. But we don’t think the labor market is too tight this time.

Unemployment rises in two ways. One is that the workforce stays the same and people lose their jobs. The other is for the workforce to increase and the number of jobs to remain the same. We’d rather see the second. Taking more time for new entrants to find a job seems healthier than big job losses.

Recently, we’ve seen an increase in the labor force and particularly among foreign-born employees.

Since the low of 2020, the foreign-born labor force (blue line) grew by 36% to 30 million compared to growth of 2% or 3 million for the rest of the workforce. It’s now at an all-time high of 19% of the workforce. That’s a big surge and counts for most of the labor force growth in the last year.

The Office of Homeland Security (OHS) only published 2022 data on the number of people obtaining permanent status in November of 2023. It showed 1,019,349 people, up 40% from the prior two years. The record was 1.3 million in 2006.

The largest sources of immigration are India (12%), Mexico (11%), and China (6%). After that, no single country is 5%. Where do they go? California (18%), Florida (11%), New York (10%) and Texas (10%), with the remainder broadly in line with state populations.

The foreign-born cohort of the labor force has a higher participation rate of 67% compared to 61% for the rest of the labor force, and lower unemployment at 3.2% versus 3.9% for the remainder. It’s younger, with 75% in the 18- to 64-year-old range compared to 59% for the native-born population. And while the foreign-born component of the work force is at an all-time high of 19%, the foreign born share of the population is 13.6% and flat for 20 years. Around 47% of immigrants have a university education or higher, compared to 35% for the rest of the population.

Industries with the highest number of foreign born participants include hotels (31%), science and technology (26%), construction (25%), and health services (24%).

We’d expect the number of foreign-born participants in the labor market to grow. It has little to do with the border crossings. Half the growth is just a change in residency status and half from new arrivals. We won’t know the official numbers for a while but we’d guess that the foreign-born labor force will continue to grow, which should ease pressure on unemployment and wages.   

What’s all this Quantitative Tightening (QT) stuff?

This is some financial plumbing stuff. Feel free to skip to the last paragraph for the tl;dr version.

Quantitative Easing (QE) was one of the Fed’s main policy tools from 2009 to 2013 and again from 2020 to 2022. It was all about buying Treasury and MBS bonds to one, provide banks with liquidity at a time of great uncertainty and two, drive rates lower. The more bonds the Fed bought, the more money flowed into banks and the lower the rates on those bonds. From 2009 to 2013, the Fed launched three buying programs and took its securities holdings from $5 billion to $4,000 billion, or a level of 23% of GDP.

The Fed started to let these securities mature in 2018 in a process called quantitative tightening (QT) and by 2019 the level fell to 16% of GDP.

When Covid-19 hit, the Fed deployed all the tools it could to prevent the economy from slipping into depression, again using QE. It took the bond portfolio to $8,400 billion and 34% of GDP. In early 2022, the Fed announced QT again to reduce the balance sheet. From September of 2022 until now, it reduced the balance sheet by $95 billion a month, of which $60 billion was in Treasuries and $35 billion in MBS.

Since 2022 the balance sheet has shrunk by $1,300 billion to $7,176 billion and 27% of GDP.

This was all going fine and wasn’t getting much attention until two weeks ago when President Lorie Logan of the Dallas Fed suggested that the run off was too fast and there may be liquidity risks ahead.

Boy, did that get things going. Here’s what she was talking about.

The blue line is the Fed balance sheet and includes all Fed liabilities. The Treasuries and MBS are on the asset side of the Fed. These are just the liabilities set against those assets. The green line shows bank deposits at the Fed, again just liabilities because the Fed owes the money to the banks. Banks record the deposits as assets on their balance sheet.

President Logan’s point was that, yes, while bank reserves have risen by around $350 billion since late 2022 to $3,489 billion now, it’s not as rosy as it looks. She cautioned that money market funds had run down their use of the Fed’s reverse repo facility from $2,146 billion to $647 billion now.

So what?

Well, money market funds held a lot of bank cash. They would go to the Fed to park that cash overnight and receive a better rate than banks’ deposits. They’re no longer doing that because they can get a better rate buying Treasury bills. Fine. But that means banks have less cash. They’re getting cash from other places, like regular personal accounts, otherwise the green line would be headed down. But Logan is not sure that’s a good sign.

She also noted that banks have had to buy more Treasuries following the big issuance calendar in the second half of 2023. When a bank buys a Treasury bond or bill, it hands over cash to the Treasury, who spends it. This means banks end up with less cash, which means less reserves. And that’s the issue. QT reduces bank reserves, which tightens the economy and cools things off.

But, again, the green line went up. So, what’s the problem?

President Logan says that while the aggregate number is fine, individual banks may have cash problems. Only the Fed, the Office of the Comptroller of the Currency (OCC) or the Federal Deposit Insurance Corporation (FDIC) knows the exact details but we can guess it from the Fed’s weekly regional Fed report. And from those reports, she’s correct. Of the $3,489 billion in reserves, 65% is at the New York Fed, up from 56% last June. The New York Fed supervises JP Morgan, Citibank, Morgan Stanley, Goldman Sachs as well as some other heavy-weight foreign banks with a U.S. presence. Their deposits are up $318 billion since last year.

Another large increase occurred at the Richmond and San Francisco Feds, who supervise Bank of America and Wells Fargo. Deposits with those two are up $382 billion in the last year. So, we just accounted for $700 billion of the $350 billion mentioned by President Logan.

It may be exactly as she said: reserves are not well distributed and there isn’t much room to reduce reserves further. She suggested that the Fed should cut back QT.

Another puzzle around QT and reserves is that the Fed used to operate a very different reserve system. This is only the second time in history that we’ve had to worry about the current system. From the Fed’s founding in 1913 to 2008, it did not pay interest on bank reserves. The Fed just sold bills to and bought bills from banks to manage liquidity. They used to change the rate depending on policy but that was all. The Fed didn’t hold bank reserves. Before 2009, bank deposits at the Fed were about $12 billion, not the $3,489 billion today.

That all changed in 2008 when the Fed started QE. QE put money into banks but banks saw little demand for loans and didn’t much like having lots of reserves around yielding nothing. So they put the money  with the Fed which, by an act of Congress in 2008, was allowed to pay interest on reserves. Right now, the Fed pays 5.4% on those reserves. They’re simply called Reserve Balances. The idea of excess and required reserves all went away in 2021.

Now that we don’t have excess, minimum or required reserves at the Fed, the question is “what is the right level of reserves?” Is it the $3,489 billion or 13% of GDP or the 11% from a year ago? Or some other number?

We don’t know. The Fed uses ample, abundant and somewhat above to describe reserve balances. They don’t really say what we’re in now, although it’s probably at least “ample.” Just a week ago, Governor Waller said the level should be around 11% of GDP or $600 billion below what it is now.

The Fed asks bank loan officers and trading desks what they think. Recently, we saw this in response to “when do you think the Fed will stop QT?”

The circled numbers are the reserve levels and the $3,125 billion estimate compares to the actual level of $3,489 billion, around $467 billion below what it is now, and closer to Governor Waller’s number.

Put this all together, and we have one Governor saying, “slow QT”, another saying, “press ahead” and the market saying, “press ahead but not for much longer.” And no one’s sure whether there are lots of or a scarcity of reserves.  

It’s confusing and the debate isn’t over. It matters because if the Fed reduces its $95 billion rate down to, say, $60 billion, that leaves the Fed with more money to buy new Treasury bonds. Every bond that matures, which is over $60 billion becomes available for reinvestment. That means lower rates and an easier road to fund the deficit.

We’d summarize that bank reserves are not evenly distributed and that the lower reserves go, the more anxious banks will become. The Fed can address that by changing the level of run-off in its balance sheet and, sometime this year, that’s what they will do. The market should take it well because Treasury financing will become marginally easier.

Yeah, sorry, that’s a lot of ink for something for money market plumbing. But it’s a debate that just resurfaced and is, unfortunately, a result of decisions made over 15 years ago. It should all be fine but expect a lot more noise until we know what the Fed’s going to do.

The Bottom Line

The best news of the week was that GDP grew 3.3% in the fourth  quarter of 2023. Most investors expected 1.8%. Consumer expenditures were slower at 2.8% compared to 3.1% but the big move was in exports, which grew 6.3%, and non-defense government capital spending which grew 4.6%. That’s probably the various infrastructure stimulus programs from 2021 working their way through. Some of the higher than expected growth was because the price deflator, which adjusts nominal to real GDP, was 1.5% versus a 2.2% estimate.

Good news on inflation too. The PCE index, which is what the Fed follows, grew 1.7% compared to 2.6% in Q3. The Fed’s target is 2.0% so one could say “job done” but they’ll wait a while to take the victory lap.

Stocks were up 0.2% on the day and 3.0% for the week. The 10-year Treasury, at 4.15%, barely moved in the last week or so.

The ECB made no changes to rates and added that rates would stay put for a “sufficiently long duration.” That didn’t seem to bother the stock markets much which were up 2.8% for the week. There was also good news from ASML, a company that provides the tools for chipmakers to make chips. Its stock jumped 24% and is now the largest company in the European stock indexes.

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Art of the Week: Phyllis Shafer (b. 1958)

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