The Federal Reserve's reserves plunged! It fell below $3 trillion, hitting a new low since 2020

Zhitong Finance APP learned that the reserves of the U.S. banking system have fallen to the lowest level since October 2020, falling below the $3 trillion mark, which affects the Fed's decision to continue to reduce its balance sheet. As of January 1, bank reserves fell by $326 billion to $2.89 trillion, the largest weekly decline in two and a half years.

The decline is related to the reduction of balance sheet-intensive activities such as repurchase agreement transactions by banks at the end of the year to strengthen regulatory books, resulting in cash flows to the central bank's overnight reverse repurchase facility (RRP), thereby reducing the liquidity of other liabilities on the Fed's books. 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 bank term funding program loans. Wall Street strategists are keeping a close eye on the minimum reserve level, estimating it should be between $3 trillion and $3.25 trillion, including the buffer.

Last month, the Fed said it would continue to shrink its balance sheet and adjust the interest rate on its RRP facility to ease downward pressure on short-term interest rates, which could temporarily ease the reserve shortage.

Discussions are intensifying about how long the Fed can continue its quantitative tightening policy without triggering memories of the situation in September 2019, when reserves in the banking system became too scarce as the Fed was shrinking its balance sheet. This shortage led to a surge in key lending rates and the federal funds rate. The central bank had to intervene to stabilize the market.

Although the Fed lowered the limit on the amount of Treasury bonds that can mature without being reinvested in June, the end of the quantitative tightening program is unclear.

The recently reinstated debt ceiling may make it more difficult for policymakers to judge the ideal reserve level, because measures taken by the Treasury to maintain the limit may artificially increase liquidity in the financial system and mask indicators of reserve scarcity. According to a New York Federal Reserve Bank survey of primary dealers and market participants, two-thirds of respondents expect quantitative tightening to end in the first or second quarter of 2025.