It is kind of hard to believe that the Fed would start to pull back in the wake of headlines like this:
Bonds Rally, but Banks Are Still Bruised
UBS needs to stem client withdrawals to turn corner
Royal Bank of Scotland May Face LyondellBasell Losses
WellPoint sees 4Q investment losses of $349M
Deutsche Bank Trading Losses Reveal Industry Setback
TIPS Irresistible to Gross as Protection Is ‘Cheap’
U.S. 10-Year Treasuries Little Changed Before Economic Reports
And Bernanke's speech today: The Crisis and the Policy Response
The Fed is just getting its various new programs underway, which have not appeared on the balance sheet yet; these programs will raise the Fed's balance sheet.
- The Fed is already purchasing MBS in support of AIG (already recorded on the balance sheet), but it only just started purchasing MBS on the open market; its holdings of MBS (likely in the SOMA account) will be recorded on future balance sheet statements.
- The Fed made changes to its Money Market Investor Funding Facility (MMIFF), which currently holds a balance of $0. If newly-eligible participants bite, then the balance sheet will rise.
- The Fed has only just announced its Term Asset-Backed Securities Loan Facility (TALF), which will be initiated in February. This will raise the Fed's balance sheet.
Originally, the Treasury Supplemental Financing Account (TSP) was created to sterilize the Fed's massive liquidity flows into the banking system. And now that the Fed has no intention of sterilizing its flows, and with the Treasury liquidating its account, the funds are returning to the banking system as reserves. Therefore, the Fed has not increased its lending programs in recent weeks.
The Fed balance sheet has been rather stable since the week ending November 19 2008, when the Treasury started liquidating the TSP account. Spanning November 19, 2008 to January 7, 2009, the balance sheet has been reduced by just $1.3 billion; the TSP account decreased by $249.7 billion; and total reserves increased by $199.4 billion (through the week ending December 31). It doesn't look like the Fed is pulling back its liquidity programs. It's on a holding pattern both until the new programs get underway, and while the Treasury calls back its funding.
It seems to me that a better proxy of a healing banking system would be a reduction in the massive amounts of excess reserve holdings. Admittedly, the rate of increase is showing signs of decline; but the level of excess reserves stood at $799 billion, or roughly $794 billion greater than the level just four months ago. That sounds like a still very stressed commercial banking system.