Back in early May, we walked through the playbook (then) Fed Governor Stephen Miran laid out on how Kevin Warsh can shrink the balance sheet without creating a liquidity shock.
Remember, the Jerome Powell-led Fed stopped and reversed on the balance sheet back in December.
And Powell said this in the post-meeeting press conference: "There’s a secular ongoing growth of the balance sheet. We have to keep reserves, call it, constant as it relates to the banking system or to the whole economy. And that alone calls for us to increase about $20 [or] $25 billion per month."
So he said this new balance sheet expansion would be "ongoing," meaning indefinite.
If "ongoing" is indeed required to "keep reserves constant," just to maintain stability in the funding markets, then how does Kevin Warsh step in and carry out his plan to shrink the balance sheet?
That was the point of that Miran speech last month.
He said the roughly three trillion dollars banks hold in reserves, which the Fed is afraid might become "scarce," is not a reflection of what banks would choose to hold in a normal market. It's a reflection of what they're made to hold, in the post-Global Financial Crisis regulatory regime.
So, the top of Miran's list of paths forward was to ease the GFC-induced over-regulation — ease the liquidity coverage ratio and the internal liquidity stress standards.
Ease those rules, and the reserves can come down. Then Warsh can shrink the balance sheet without breaking funding markets.
And then the capital that has been trapped in the banking system gets freed.
And that capital gets freed in the form of pro-economic things like, loans to consumers and businesses.
With all of this in mind, the results of the Fed's annual bank stress test were released today. And they are "well positioned to weather a severe recession." The banks got an all-clear with room to spare.
And that all-clear signal was met, almost immediately, with announcement from major banks of dividend increases. Capital freed from the regulatory noose, and a wall of cash payouts starts.
This, on the same afternoon as the stress test results, should signal the regulatory regime is loosening, and credit growth is coming.
And this comes on the same afternoon that Micron answered the questions about the durability of AI demand, unequivocally.
Revenue of $41 billion against $9 billion a year ago (not a typo).
Gross margins up 10 percentage points to 85%.
Earnings per share more than doubling from last quarter.
Next-quarter revenue guidance of $50 billion, well above the Street.
So two of the market's standing fears were tested on the same day. One, the fear AI demand is rolling over. The other, a decade old, the fear that banks are permanently capital-constrained utilities.
Both were answered clearly within hours of each other.
