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HomeEconomyU.S. bank reserves steady, easing liquidity drain fears

U.S. bank reserves steady, easing liquidity drain fears

By Davide Barbuscia

NEW YORK (Reuters) – Fears of a drain on liquidity from the U.S. banking system have yet to materialize as the Treasury Department replenishes coffers, and instead a recent increase in reserves eased some fears that the bond boom could lead to a further credit crunch.

After the government debt ceiling was suspended last month, the US Treasury Department began rebuilding accounts through Treasury bills. The Fed’s Treasury General Account has increased by approximately 460 billion dollars since early June.

In general, an increase in government borrowing coincides with a decline in demand for the Fed’s overnight reverse repurchase facility (ON RRP), through which money market funds lend to the Fed, or a decline in banks’ reserves at the central bank.

When banks absorb new debt issuance, they have less money to lend against – a situation some investors worry about given persistent fears that credit will tighten too much amid an economic downturn. However, this week Fed data showed that reserves rose by about 22 $500 million to $3 22 trillion in the week ending July 22, while demand for the ON RRP facility fell by 22 $300 million.

“As more cash leaves the RRP facility, the near-term risk of a reserve shortfall has receded,” said Gennadiy Goldberg, director of US rates at TD Securities US Inc.

“We’ll be watching the balance sheet over the next few months to see if things change materially, but I think for now the risks are down,” he added.

Demand for the Fed’s reserve requirement ratio has been falling steadily, from $2.3 trillion at the end of May to $1.7 trillion on Friday.

“At the end of May, we expect more money to drain from bank reserves, as our Citi analysts said in a note this week that money market funds are expected to keep money ON RRP as the Fed remains hawkish at the June FOMC (Federal Open Market Committee) meeting.

“However, money market funds shifted their allocation from the RRP facility to outright purchases of Treasuries and the private repo market,” they said.

Fed officials are increasingly tracking the sum of reserves and ON RRP balances to get a more complete picture as they continue to reduce central bank bond holdings at a target of nearly $10 billion a month, reducing industry liquidity. The total is now $5.3 trillion, the lowest level in about two years, down $1 billion since April, with most of the decline coming from the ON RRP, but Fed officials have yet to recognize the threat to a reserve shortfall.

Looking ahead, Citi analysts say they expect ON RRP to continue Decline, albeit a smaller one, as Treasury’s financing operations are expected to lose some steam.

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