The reserve of the Bank of America system has significantly decreased, falling below the $3 trillion mark, reaching the lowest level since October 2020.

According to data released by the Federal Reserve on the 3rd, bank reserves decreased by about $326 billion in the week ending January 1, 2025, bringing the total down to $2.89 trillion. This marks the largest weekly drop in two and a half years.

According to Bloomberg, this significant decline mainly occurred at the end of the year because banks reduced operations on their balance sheets, such as repurchase agreement trades, to meet regulatory requirements.

This led to a massive influx of funds into the Federal Reserve's overnight reverse repurchase agreement (RRP) tool, thereby consuming the liquidity of other liabilities on the Fed's balance sheet. Data shows that from December 20 to December 31, the RRP balance increased by $375 billion, and again rose by $234 billion on Thursday, January 4.

The Federal Reserve's QT is ongoing.

Analysis believes that this phenomenon is closely related to the Federal Reserve's ongoing quantitative tightening (QT) policy. The Fed is gradually withdrawing excess funds from the financial system through the QT program, while financial institutions are also continuing to repay loans obtained from the Bank's regular financing program.

Federal Reserve officials clearly stated at last month's meeting that they will continue to advance the process of reducing the balance sheet.

Wall Street strategists have been closely monitoring the minimum comfort reserve levels in the banking system. Some analysts estimate that this level, including buffer funds, should be between 3 trillion and 3.25 trillion USD.

To exert downward pressure on short-term interest rates, the Federal Reserve has also adjusted the rate of the RRP tool to align it with the lower limit of the federal funds rate target range.

When will QT pause? The market is concerned that the Federal Reserve's balance sheet reduction could trigger a liquidity crisis.

Although the Federal Reserve lowered the upper limit on the amount of U.S. Treasuries allowed to mature without reinvestment last June, it is currently unclear when this QT plan will completely end. There is controversy in the market about how long the Federal Reserve can maintain its Quantitative Tightening strategy without provoking a market turmoil similar to that of September 2019.

Looking back at September 2019, the reduction of the Federal Reserve's balance sheet resulted in reserves on the market becoming overly scarce, causing key lending rates and the federal funds rate to spike, forcing the Federal Reserve to intervene to stabilize the market.

Additionally, the recently revived debt ceiling issue may make it harder for policymakers to accurately determine the ideal reserve level. To keep the debt size below the ceiling, the U.S. Treasury typically implements certain measures that could artificially increase the liquidity in the financial system, thus obscuring the signals of actual reserve scarcity.

According to a survey by the New York Federal Reserve's Open Market Desk, two-thirds of respondents expect that the Quantitative Tightening strategy will conclude in the first or second quarter of 2025.