Barclays analysts warn that while bank reserves remain ample, their glut may not last much longer. The Barclays analysis indicates that the transition to a steeper part of the reserve demand curve, where interest rates rise, could occur when reserves reach about $3.1 trillion.
The analysts expect the quantitative tightening (QT) to be completed in December.
Currently, Barclays says reserves are not scarce, as evidenced by the stable FF-IORB spread, which has remained at -7 basis points since the start of the Federal Reserve’s rate hike.
However, the bank notes that this spread may soon narrow. “Banks’ demand curve for reserves is non-linear, and the sensitivity of the FF-IORB spread to changes in the level of reserves increases as these balances shrink,” the note said.
Barclays emphasizes the importance of monitoring changes in the slope of the demand curve for reserves, or the demand elasticity of the fund rate, to determine the shift from abundant to scarce reserves.
According to their models, banks are approaching the steeper part of this curve, which is estimated to contain about $3.1 trillion in reserves, assuming Reverse Repurchase Agreement (RRP) balances are close to zero.
They note that the Fed faces uncertainty about the pace at which QT will push banks into this steeply sloped part of the demand curve.
Barclays points out that the reserve demand curve may have shifted, meaning banks may want to hold more reserves at any level of the FF-IORB spread. In response to these uncertainties, the Fed has started to taper government bonds, indicating a cautious approach.
Barclays concludes: “There are currently no signs of reserve scarcity,” as evidenced by the flat and still negative FF-IORB spread and other market indicators. However, the analysts warn that this situation could change and emphasize the need for close monitoring as the year progresses.”
