The Federal Reserve releases a new indicator, showing ample reserve levels, indicating that QT can continue to advance

On Thursday, according to a monthly indicator released for the first time by the Federal Reserve Bank of New York, the size of the reserve in the U.S. banking system remains ample, indicating that the Federal Reserve can continue to reduce the liquidity of the financial system through its Quantitative Tightening (QT) plan.

Specifically, the new indicator released by the New York Fed, named Reserve Demand Elasticity (RDE), shows that as of October 11th, the reserve levels in the U.S. banking industry are still sufficient. This result is in line with the expectations of Wall Street strategists.

RDE is a real-time assessment of the adequacy of reserves in the U.S. banking industry, based on federal funds transaction data collected by the Federal Reserve and total reserve data from deposit institutions. The estimation also uses daily reserve balance rate data and weekly total assets data from commercial banks.

Gara Afonso, the head of banking research at the New York Fed, and others stated:

Due to the ample reserves in the system, the average level of RDE has remained close to zero from late 2014 to the end of 2017.

As the Federal Reserve reduced its balance sheet in 2018 and 2019, the sensitivity of federal funds rates to reserves increased, leading to a negative slope of the demand curve, ultimately causing dysfunction in the money markets. This situation is still mentioned by Wall Street strategists when evaluating the Fed's current balance sheet reduction plan.

Subsequently, as the Federal Reserve injected liquidity into the banking system to control short-term rates, RDE returned to levels close to zero.

The New York Fed stated that the latest estimate is no different from zero, indicating that changes in the federal funds rate have not significantly affected the supply of reserves.

The Federal Reserve Bank of New York is the specific operational institution for the Federal Reserve's balance sheet policy. Earlier this year, the New York Fed projected that it may end the balance sheet reduction by early next year or mid-year, with bank reserves decreasing from the current approximately $3.6 trillion to $2.5 trillion or $3 trillion, and the balance sheet size shrinking to around $6 trillion or $6.5 trillion. The latest data shows that the size of reserves in the U.S. banking industry is approximately $3.2 trillion.

Barclays Bank analyst Joseph Abate pointed out that this reading suggests that the Federal Reserve can continue QT until 2025.

Gennadiy Goldberg, the head of U.S. interest rate strategy at TD Securities, stated that the Federal Reserve seems to be using this new tool as an early warning signal for reserve shortages. From a risk-return perspective, it is reasonable for the Federal Reserve to remain cautious when further reducing the size of its balance sheet, especially to avoid a repeat of the events of September 2019 as the country approaches the debt ceiling period next year.

In September 2019, the U.S. repo market experienced a brief but severe liquidity shock, known as the "repo crisis." On September 17, 2019, the U.S. SOFR rate surged to 5.25%, spiking to 10% intraday, well above the upper limit of the then Federal Reserve target rate range of 2.25%. At that time, the Federal Reserve was ending its balance sheet reduction, concluding a tightening cycle; against the backdrop of significantly reduced U.S. dollar liquidity, the Treasury issued debt after raising the debt ceiling; In addition, factors such as tax season and RLAP regulation are also "coming together".

Since 2022, the Federal Reserve has been gradually reducing the size of its balance sheet, allowing U.S. Treasuries and Mortgage-Backed Securities (MBS) to naturally mature off its balance sheet without reinvestment. The Fed initially allowed the scale of Quantitative Tightening (QT) to increase, but starting from June this year, it has slowed down the pace of QT: the monthly cap for reducing U.S. Treasuries has been lowered from $60 billion to $25 billion, while the cap for reducing MBS remains unchanged at $35 billion