Introduction

It is a pleasure to offer closing remarks after another excellent U.S. Treasury Market Conference.¹ A well-functioning and liquid Treasury market is in all of our interests, and indeed the national interest. This conference is an vital forum that brings together policymakers,academics,regulators,market participants,and others to step back from the day-to-day and discuss big-picture issues that affect this vital market.

It took a lot of behind-the-scenes work to put together this event, and I want to thank all the staff from the Joint Member Agencies who contributed to making the day run so smoothly.² I also want to thank the excellent speakers we heard from for sharing thier insights, and everyone who came and participated in this event.

As the System Open Market Account (SOMA) Manager, it is indeed my job to brief the Federal Open Market Committee (FOMC) on financial market developments and oversee the Open Market Trading Desk’s (the desk) execution of monetary policy as directed by the FOMC. A particular focus over recent months has been monitoring and assessing reserve conditions, to assist the Committee in determining when it would be appropriate to stop shrinking the balance sheet. As you know,the Committee made that decision at its October meeting,with portfolio runoff ending effective December 1.³ In my remarks today, I will discuss the changes in money markets that prompted that decision and outline some next steps for management of the Federal Reserve’s balance sheet.

But, first, let me offer the usual disclaimer that these views are my own, and not necessarily those of the federal Reserve Bank of New York, the Federal Reserve System, or any other institution.⁴

A Brief Review of Balance Sheet Reduction

Let me start with a little history. As you know, the Federal Reserve added a significant amount of assets to its balance sheet between March 2020 and early 2022 to support the economy and the smooth functioning of financial markets (Panel 1 and 2). Thanks to the ample reserves monetary policy implementation framework that the Committee officially adopted in 2019, the additional reserves created by those asset purchases did not impair the Federal Reserve’s ability to control the federal funds rate.⁵ still, many of those reserves were not necessary for rate control. Actually, reserves were so plentiful that banks no longer found it necessary to compete for them, and excess liquidity migrated from the banking sector to money market funds. In terms of the Federal Reserve’s balance sheet, this showed up as reserves fluctuating between $3.1 trillion and $3.4 trillion for most of the runoff period, with occasional excursions outside that range (Panel 3 and 4). A large portion of the additional liquidity created by asset purchases instead appeared as balances in the Fed’s overnight reverse repo facility (ON RRP). Usage of that facility rose well above $2 trillion.

In May 2022 the Committee announced its plans for reducing the size of the balance sheet and said that it would do so until reserves reached a level somewhat above ample.⁶ As I have discussed previously, I believe that market indicators can be a useful tool for determining when reserves approached ample, rather than trying to estimate that level ex ante.⁷ When reserves are abundant, banks have little incentive to hold onto a marginal dollar of reserves for precautionary reasons, and money market rates are generally stable and close to the floor set by our administered rates. As reserves move from abundant toward ample levels, money market rates become more responsive to changes in reserves and start moving upward relative to administered rates.

Indeed,as the balance sheet shrank,money market conditions gradually tightened,and we observed first the reemergence of repo

Reserve Conditions and Recent Rate Pressures

Recent weeks have shown notable upward pressure in money market rates,prompting increased usage of the Standing Repo Facility (SRF). This shift indicates that reserves are no longer abundant,a change from the conditions experienced over the past several years. panel 10 illustrates the recent increase in the minimum bid rate on some days, and the facility has seen more frequent usage and larger volumes.

Tri-party repo rates occasionally rising somewhat above the top of the target range is not concerning because the target range is defined in terms of the federal funds rate. It is indeed also not unheard of from a ancient perspective as repo rates are inherently more volatile than federal funds rates (Panel 11). However,tri-party repo rates persistently or substantially above the top of the target range would be more problematic because they could pull up the EFFR and pose difficulties for rate control. This is why having a ceiling tool like the SRF is of fundamental importance.

Even though the SRF has seen more frequent usage of late, a notable amount of repo transactions still have taken place in the market at rates above the SRF minimum bid rate. Our market outreach suggests that some dealers may be unwilling to negotiate with money market funds, or divert funding to the SRF in large size, if repo pressures are moderate and only expected to last for short periods of time. In part this might be because relationships matter in the repo market; dealers value the stable funding flows that money market funds provide, and if the added cost of borrowing from a money market fund at a somewhat elevated rate is only modest, they may prefer to absorb that cost. This may change, though, as SRF usage becomes more commonplace-similar to how the existence of the ON RRP came to provide money market funds with negotiating power when reserves were abundant, and in so doing provided the Fed with very strong rate control. And even as of now, if repo pressure persisted, or intensified, I do expect that the SRF will be used more broadly and to a much larger extent, thus dampening the upward rate pressure. I will have some more thoughts on the SRF shortly.

Returning to our assessment of reserve conditions, the rate pressures I mentioned also resulted in notable movement in some of our reserve ampleness indicators, as shown in the spiderweb chart in Panel 12. The share of repo transactions taking place at rates above IORB has reached levels seen in late 2018 and 2019. The share of interbank payments settled late in the day has also shifted out to late-2018 and 2019 levels as banks have delayed payments, possibly to economize on reserves. And the share of borrowing in the federal funds market by domestic banks has increased as well, albeit less so.

The estimated elasticity of the demand curve for reserves has thus far remained stable.¹⁴ The estimation,though,is highly likely being contaminated by the lagged effects of the debt limit situation; in the period ahead,we would expect that we will see the elasticity becoming progressively larger,like it did in 2018 when the federal funds rate started increasing.

Considered together, higher money market rates, increased SRF usage, and shifting reserve ampleness indicators are strong evidence that reserves are no longer abundant. In its May 2022 plans, the Committee stated that it would stop runoff when reserves were som