Barclays strategist Joseph Abate said in a reportmonstersofrockmegawaysThe balance of the Federal Reserve's overnight reverse repo (RRP) facility has stabilized, which could cause reserves to be scarce later this year.
Since April, RRP usage has been hovering around $450 billion. This may be caused by temporary factors such as the flow of tax funds, as well as the upcoming money-market fund reform and policy prospects.
As institutional high-quality funds convert to funds that only invest in government bonds, or investors withdraw, the balance of government bond funds will increase, boosting demand for U.S. Treasuries, agency bonds and repurchase agreements.
As the Fed moves closer to easing policy and bond yields with three-month and shorter maturities fall, portfolio allocations may change and more funds may shift away from RRP to repurchase.
However, Abate said that means the demand outlook for RRP "may become more rugged and not necessarily plummet as it has in the past 12 months."
The uncertain outlook for RRP means bank reserves could fall to 2.2 per cent by Decembermonstersofrockmegaways.8 trillion to $2.9 trillion, especially if use of the tool remains around $300 billion to $400 billion.
"Our sense is that even without signs of interest rate pressure, this is close to the minimum comfortable reserve level for banks (with little cushion) when the Fed ends quantitative tightening directly," Abate wrote.