According to recent information, the reserves in the U.S. banking system (a key consideration for the Federal Reserve to continue reducing its balance sheet) have once again fallen below $3 trillion. Concurrently, Federal Reserve Chairman Jerome Powell has signaled that quantitative tightening (QT) may come to a halt in the next few months. Data released by the Fed on Thursday shows that bank reserves decreased by approximately $45.7 billion in the week ending October 15, bringing the total down to $2.99 trillion. This decline almost offsets the previous week’s increase of $54.3 billion. The decrease in reserves follows the increase in U.S. Treasury bond issuance since the debt ceiling was raised in July, aimed at rebuilding cash balances. This activity drains liquidity from other liability items in the Fed’s accounts, such as the overnight reverse repurchase agreement (RRP) tool and bank reserves. However, as RRP balances approach depletion, reserves held by commercial banks at the Fed continue to decline. The drop in cash assets held by foreign banks has even outpaced that of domestic banks. As the Fed continues to pursue balance sheet reduction (QT), these liquidity shifts affect the daily operations of the financial system. Due to concerns that QT could exacerbate liquidity pressures and cause market turmoil, the Fed has slowed the pace of its balance sheet reduction earlier this year, decreasing the scale of allowed monthly bond roll-offs. Powell stated on Tuesday that the reduction of the balance sheet will stop when reserves are slightly above what policymakers deem “adequate” (the minimum needed to prevent market turmoil). He explicitly noted that the Fed may be approaching this level “in the next few months,” representing the strongest signal yet that the Fed believes this target is near. Fed Governor Christopher Waller mentioned in an event on Thursday that the current scale of the balance sheet has returned to a reasonable level corresponding with “adequate reserves.” Back in July, Waller estimated the minimum adequate level of reserves to be around $2.7 trillion. “We maintain an adequate level of reserves to ensure that the banking system and financial markets have sufficient liquidity, ultimately avoiding situations where institutions scramble to raise small amounts of capital to fill reserve gaps,” Waller stated. “In my view, such a liquidity crunch is absurd.” Due to these liquidity changes, the effective federal funds rate, which is the Fed's policy target, saw a slight rise last week within the target range—marking the second increase in over two weeks, indicating that future financial conditions may tighten further. This rate remains within the 4% to 4.25% range set after last month's rate cut by the Federal Open Market Committee (FOMC). For the past two years, this rate has hovered near the lower limit of that range. Deutsche Bank noted that the 75th percentile of this rate rose from 4.10% to 4.12% this week, suggesting that the median rate may increase further. The federal funds market, once a critical channel for overnight interbank borrowing and often used as an indicator of tightening financing conditions, has seen banks significantly withdraw from it during the financial crisis and the pandemic due to the massive monetary stimulus that flooded the U.S. banking system with dollars, redirecting funds straight into the Fed. As a result, the trading volume behind the federal funds rate has decreased. On one hand, there is less excess funding available for non-U.S. institutions in the market; on the other hand, the Federal Home Loan Banks, as the largest lending group in this market, are directing more funds toward the repurchase market due to higher rates there.