Fed Sees Big Holiday Demand for Cash, Bank Reserves

NEW YORK -- With the arrival of the holiday shopping season, the Federal Reserve faces the biggest demand of the year for currency and added bank reserves.

Analysts say the seasonal trend is bound to occur whether the economy is humming along or just barely moving.

Cash Withdrawals

"No matter what the business environment is, boom or recession, the country's need for currency rises sharply, requiring the Fed to take offsetting [reserve] action," said Dean Witter Reynolds' William Sullivan, who sees currency in circulation rising $7 billion to $8 billion by Christmas.

As Christmas approaches, people withdraw more cash from their bank accounts than at any other time of year. These withdrawals drain bank reserves, which the Fed offsets by adding liquidity in the money markets. The big Fed operations contribute to volatility in federal funds, already choppy due to yearend pressures.

Also contributing to the Fed's management problems is the climb, also tied to holiday commerce, in reserves that banks are required to hold against business deposits. Banks must set aside 12% against deposits, and additional reserves drain cash from the banking system.

James Fralick of Morgan Stanley & Co. said he sees currency in circulation rising by about $7 billion, to $306 billion, between mid-November and Christmas. Since 1986, the range of currency increases in the last six weeks of the year has been $5.97 billion to $7.77 billion.

This year's rise could be larger than normal because interest rates are at their lowest levels in 10 years, giving depositors less incentive to keep money in the bank.

Economists have forecast that the Fed will add temporary reserves of $1.75 billion to $3.25 billion a day in the two-week maintenance period ending Nov. 27 to offset the incipient rise in currency.

What is known as the "add need" grows larger in the following period, which ends Dec. 11, when the Fed is seen as likely to inject $5 billion to $6 billion a day.

That higher demand will likely prompt a permanent addition to reserves, economists said. They said they expect the Fed to inject permanent reserves through a purchase of Treasury coupons or bills, lightening the Fed's daily add need.

Treasury Debt Purchase

"The add need is large enough to warrant another outright purchase of Treasury debt before the end of the month," Mr. Sullivan said. The Fed has added permanent reserves once already in the holiday runup, buying slightly less than $2.4 billion of Treasury bills from dealers Oct. 30.

Speculation differs on whether the reserve injection will come the week before Thanksgiving or later. A third outright purchase would be very unusual.

"They don't want to do too many bill passes and have to drain reserves," said Stephanie Murphy, an economist at Manufacturers Hanover Securities Corp.

In January, the Fed will shift very quickly into a reserve-draining mode as the demand for currency falls to its annual low.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.