Reserves and Asset Prices

Published on June 5, 2023 by Premium

A rapid decline in bank reserves is a headwind to all asset prices, but it need not be significant. In our two-tiered monetary system, a decline in bank reserves means both banks and non-bank investors have less cash and thus potentially less demand for financial assets. Banks may have less demand for high quality liquid assets like Treasury securities and non-bank investors may have less demand for riskier assets. In addition, while a decline in

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Probing LCLoR

Published on May 15, 2023 by Free

Bank reserves are on track to approach a common estimate of the Lowest Comfortable Level of Reserves (“LCLoR”) within a few months. At the moment, reserves sit around $3.2t and a common Fed estimate places LCLoR at around $2.2t (8% of GDP). In addition to quantitative tightening, two events may soon reduce bank reserves to around $2.2t. First, the RRP is likely to steadily increase as MMF assets continue to rise and FHLB debt issuance

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Come Hell or High Water

Published on January 23, 2023 by Free

Governor Waller suggests two significant changes to the Fed’s QT framework that effectively removes all obstacles to an extended QT. First, Waller suggests that the $2t in RRP balances should be consolidated with bank reserves when thinking of bank liquidity levels. This indicates that the Fed would be comfortable with bank reserve levels dropping below the roughly estimated $2.5t minimum level. Second, Waller appears to be open to maintaining QT even if policy rates are

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Turbo Tightening

Published on May 31, 2022 by Free

The money supply is set to contract just as investors are clamoring for cash to hide from declines in both equities and bonds. A combination of increasing MMF allocation to the RRP and QT may drain ~$1t of bank deposits by the end of the year. The Treasury’s decision to further cut bill issuance will keep money market rates very low and likely push the RRP to over $2.5t by the end of the year.

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Reserve Demand Post-SRF

Published on August 2, 2021 by Free

The Fed’s new domestic Standing Repo Facility (“SRF”) makes Treasuries more fungible with reserves and will thus slightly impact the composition of GSIB liquidity portfolios. Post-Basel III GSIBs are required to hold large High Quality Liquid Asset (“HQLA”) portfolios that in practice largely consist of reserves. Although reserves and Treasuries are equal under the letter of Basel III, regulators prefer banks to hold reserves because they are more liquid. This distinction was further highlighted last

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Can Banks Spend Their Reserves?

Published on September 10, 2020 by Free

Bank reserves can never leave the balance sheet of the Fed, but that does not limit how they can be spent. Reserves are a form of money and can be spent on anything. However, banks transact with other banks in a different way than how banks transacts with non-banks. This is due to our two-tiered monetary system, where not everyone is eligible to hold reserves. For the cryptocurrency fans: this is the equivalent of a

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What Determines the Level of Bank Reserves

Published on September 7, 2020 by Free

The level of commercial bank reserves is determined by the size of the Fed’s balance sheet, and the proportion of reserves that end up in the Fed accounts of banks. When the Fed purchases securities or makes loans, it creates reserves out of thin air to fund them. A $100 purchase of Treasury securities results in the creation of $100 in reserves. A $100 FX Swap loan also creates $100 in reserves. Reserves can only

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Two Tiered Monetary System

Published on August 29, 2020 by Free

We have a two tiered monetary system, where one type of money is used when transacting with the Fed and between commercial banks (reserves), and another type of money is use when transacting with everyone else (bank deposits). This note explains the two types of money, and how they interact with each other. Fed Reserves Reserves are an unsecured liability of the Fed that can only be held by entities with an account at the

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