The Federal Reserve's reserves plummet! Falling below $3 trillion, hitting a new low since 2020
The reserves of the U.S. banking system have fallen to their lowest level since October 2020, dropping below $3 trillion, which affects the Federal Reserve's decision to reduce its balance sheet. Reserves decreased by $326 billion, marking the largest weekly decline in two and a half years, primarily due to banks reducing repurchase agreement transactions at the end of the year. Wall Street strategists are paying attention to reserve levels, expecting them to be between $3 trillion and $3.25 trillion. The Federal Reserve will continue to reduce its balance sheet and adjust the RRP tool rate to alleviate downward pressure on short-term interest rates. The end date for quantitative tightening remains unclear
According to Zhitong Finance APP, the reserves of the U.S. banking system have fallen to their lowest level since October 2020, dropping below the $3 trillion mark, which impacts the Federal Reserve's decision to continue reducing its balance sheet. As of January 1, bank reserves decreased by $326 billion to $2.89 trillion, marking the largest weekly decline in two and a half years.
This decline is related to year-end banks reducing balance sheet-intensive activities such as repurchase agreement transactions to strengthen regulatory books, leading cash flows to the central bank's overnight reverse repurchase agreement (RRP) tool, thereby reducing the liquidity of other liabilities on the Federal Reserve's balance sheet. Between December 20 and December 31, the RRP balance increased by $375 billion, and then decreased by $234 billion on Thursday.
The Federal Reserve continues to remove excess cash from the financial system through its quantitative tightening program, while institutions continue to repay loans from the Bank Term Funding Program. Wall Street strategists are closely monitoring the minimum reserve levels, estimating that including buffers, reserve levels should be between $3 trillion and $3.25 trillion.
Last month, the Federal Reserve stated it would continue to reduce its balance sheet and adjust the interest rates on the RRP tool to alleviate downward pressure on short-term rates, which may temporarily ease the reserve shortage issue.
Currently, discussions are intensifying regarding how long the Federal Reserve can maintain its quantitative tightening policy without triggering memories of the situation in September 2019. In September 2019, when the Federal Reserve was reducing its balance sheet, reserves in the banking system became too scarce, leading to spikes in key borrowing rates and the federal funds rate. To stabilize the market, the central bank had to intervene.
Although the Federal Reserve lowered the cap on the amount of Treasury securities allowed to mature without reinvestment in June, the end date for the quantitative tightening program remains unclear.
The recently reinstated debt ceiling may make it more difficult for policymakers to gauge the ideal reserve level, as measures taken by the Treasury to maintain the ceiling could artificially increase liquidity in the financial system and obscure indicators of reserve scarcity. According to a survey by the New York Federal Reserve Bank of primary dealers and market participants, two-thirds of respondents expect quantitative tightening to end in the first or second quarter of 2025