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Fed's New Reserve Metric Signals Green Light for Continued Tightening

AInvestThursday, Oct 17, 2024 7:00 pm ET
1min read

On Thursday, the New York Federal Reserve released a new monthly metric indicating the ample level of reserves in the U.S. banking system, suggesting that the Federal Reserve can continue its quantitative tightening (QT) strategy to reduce liquidity in the financial system.

This newly unveiled metric, named the Reserve Demand Elasticity (RDE), reveals that as of October 11, reserve levels in U.S. banks remain robust. This outcome aligns with the expectations of Wall Street strategists.

RDE serves as a real-time assessment of the sufficiency of reserves in the U.S. banking sector. It relies on federal funds transaction data and total reserve figures from depository institutions, along with federal funds rates data and weekly commercial bank total assets data.

In recent statements, the New York Fed noted that the current estimates effectively equate to zero. This implies that changes in the supply of reserves have not significantly impacted the federal funds rate.

The New York Fed acts as the operational arm for implementing the Fed's balance sheet policies. Earlier this year, projections indicated that balance sheet reductions might be concluded by early to mid-next year, with bank reserves decreasing from around $3.6 trillion to between $2.5 trillion and $3 trillion. The latest data shows that U.S. bank reserves are approximately $3.2 trillion.

Joseph Abate, an analyst from Barclays, pointed out that these indicators suggest that the QT could continue until 2025.

Gennadiy Goldberg, head of U.S. rates strategy at TD Securities, mentioned that the Fed appears to be using the RDE metric as a warning tool for potential reserve shortages. It seems prudent for the Fed to maintain caution when further reducing its balance sheet size, especially to avoid a repeat of the September 2019 market events during potential future debt ceiling constraints.

Since 2022, the Fed has been gradually trimming its asset holdings, allowing U.S. Treasuries and mortgage-backed securities (MBS) to mature without reinvestment. Initially, the QT scale increased, but as of June this year, the QT pace has moderated: the monthly cap on U.S. Treasuries has been lowered from $60 billion to $25 billion, while the MBS cap remains at $35 billion, highlighting the Fed's cautious approach.

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