Ah, the ever-delicate dance of quantitative tightening—where the Federal Reserve plays the maestro, and the financial markets pray they don’t miss a step. US banking system reserves have dropped below the $3 trillion mark for the first time since October 2020, settling at $2.89 trillion. According to the Fed’s data released last week, this represents a jaw-dropping $326 billion plunge in just one week—the steepest drop in over two years.

This dramatic decline comes from the year-end liquidity shuffle, where banks, in their regulatory wisdom, scale back balance-sheet-intensive activities like repo transactions to tidy up their books. Instead, funds flow into the Fed’s reverse repo facility, soaking up liquidity from other liabilities on the central bank’s balance sheet. The RRP balances ballooned by $375 billion between December 20 and 31 before sharply deflating by $234 billion on Thursday. It’s the financial equivalent of a New Year’s Eve hangover.
Meanwhile, the Fed continues its quantitative tightening (QT) campaign, steadily siphoning excess cash from the financial system. At the same time, banks chip away at their loans under the Bank Term Funding Program.

Wall Street strategists, clutching their crystal balls, have pegged a critical reserve floor somewhere between $3 trillion and $3.25 trillion, factoring in a “buffer”—because you can never be too careful. Fed policymakers have stated their commitment to shrinking the balance sheet, but the clock is ticking, with reserves now below this theoretical safety zone.
To stave off any immediate liquidity crises, the Fed has tinkered with the RRP facility’s offering rate, aligning it with the lower end of the federal fund’s target range. This tweak has nudged short-term interest rates downward and, optimistically, may hold off a reserve crunch—for now.

But let’s not forget the ghost of September 2019, when reserves dwindled to dangerously low levels amid the Fed’s balance-sheet trimming, sparking a spike in repo rates and forcing the central bank to step in as the reluctant hero. How long the Fed can continue its QT serenade before history repeats itself is a question.

In June, the Fed modestly adjusted its cap on Treasury runoff, a subtle nod to the challenges of managing this monetary contraction. But don’t expect clarity anytime soon when the QT curtain finally falls. The recent reinstatement of the debt ceiling only muddies the waters further. Treasury’s manoeuvres to stay under the ceiling inject artificial liquidity into the system, masking the tell-tale signs of reserve shortages.

According to the Fed’s latest surveys, two-thirds of primary dealers and market participants expect QT to wrap up by the first or second quarter of 2025. But as any seasoned Fed watcher knows, timelines in monetary policy are about as reliable as long-range weather forecasts.
For now, the financial world watches with bated breath as the Fed continues its balance-sheet tightrope act, hoping the central bank doesn’t slip and send markets tumbling. After all, nobody wants to relive the liquidity drama of 2019—but if there’s one thing markets love, it’s a sequel.