NEW YORK, Oct 17 (Reuters) – The Federal Reserve faces no imminent market liquidity challenges that could stop the ongoing contraction of its balance sheet, according to a new tool launched Thursday by the Federal Reserve Bank of New York.
The new tool is designed to serve as an early warning indicator of impending reserve scarcity. The bank said in a blog posting that the measure will help spot the transition point between abundant levels of liquidity, toward the “ample” but undefined level of reserves policymakers say they are aiming for.
As of data available on Oct. 11, the measure indicates “reserves remain abundant. These latest RDE estimates are indistinguishable from zero, meaning that the federal funds rate does not significantly respond to shifts in reserve supply.” For reference, negative RDE readings suggest tighter liquidity.
The QT process has been running for a little over two years, with the Fed contracting the overall size of its holdings from a peak of $9 trillion to the current level of $7.1 trillion. The Fed is seeking to withdraw unneeded liquidity as part of an overall normalization of monetary policy in the wake of the coronavirus pandemic.
The Fed wants to make sure there is enough liquidity in the financial system to allow it firm control over the federal funds rate, its chief monetary policy tool to influence the economy. The challenge for Fed officials is that it’s unclear the point at which point liquidity becomes too scarce and money market rates become too volatile.
So far, the process of shrinking Fed holdings has largely come on the back of draining cash out of the central bank’s reverse repo facility, which has come down substantially over the course of this year.
Meanwhile, banks’ collective reserve levels have been little changed for an extended period and until they start to fall, most observers reckon the Fed will be able to continue with QT.
Ahead of the New York Fed announcement, analysts at investment bank Barclays said “we expect bank reserves will remain just above the ample threshold at year-end.” They continue to expect QT to end this year, ahead of where many other traders and investors reckon.
The New York Fed said it will update on 10 a.m. ET on the third Thursday of every month, with exceptions to deal with Federal Open Market Committee meeting dates.
Sign up here.
Reporting by Michael S. Derby; Editing by Chizu Nomiyama and Nick Zieminski
Our Standards: The Thomson Reuters Trust Principles., opens new tab