(April 19): The amount of reserves in banking system — a key determinant for the Federal Reserve to continue shrinking its balance sheet — dropped by the most in two years as Americans paid income tax bills out of their bank accounts.

Bank reserves totalled US$3.33 trillion (RM15.9 billion) in the week through April 17 from US$3.62 trillion the prior week, Fed data show. The US$286 billion decline is the largest since the April 2022 tax deadline.

Market participants and policymakers are closely tracking the amount of cash banks park at the Fed to gauge what level is sufficient to maintain liquidity and avert ructions in financial markets. As reserves push closer to scarcity, a level primary dealers estimate to be between US$3 trillion and US$3.25 trillion, the US central bank will likely have to consider altering the trajectory of its balance-sheet unwind — a process known as quantitative tightening.

The current tally suggests reserves are running at a level policymakers would characterise as abundant, and they’re aiming for ample, which chair Jerome Powell defined at a press conference after last month’s policy meeting as “a little bit less” than that. Still, minutes of that gathering showed a vast majority of officials judged it would be prudent to slow the pace of runoff fairly soon.

For now, short-term funding markets have been stable and stress free, which offers considerable flexibility as officials consider the path ahead for QT. If the Fed lets reserves shrink too much it risks triggering volatility in overnight funding markets similar to what was seen in September 2019. However, too many reserves consume bank capital and inhibit lending, and ensure the Fed bank maintains a large footprint in the Treasury cash and repo markets.

Scarcity has caused problems in the past, most notably in September 2019, when a confluence of factors including a sudden increase in corporate tax payments along with a slug of bond issuance prompted demand for liquidity to suddenly surge. That sent overnight funding markets into a tailspin and forced the Fed to intervene.