The scale of reserves at Bank of America has continuously declined, falling below 3 trillion. The Federal Reserve may face a critical decision at next week's interest rate meeting

The Zhitong Finance APP noted that the reserve levels in the U.S. banking system have declined for the second consecutive week, further dropping below $3 trillion. Reserves are a key consideration for the Federal Reserve in deciding whether to continue reducing its balance sheet, and this comes at a time when the Fed is about to determine the path of its balance sheet.

According to data released by the Federal Reserve on October 24, as of the week ending October 22, bank reserves decreased by approximately $59 billion, falling to $2.93 trillion, the lowest level since the week of January 1.

This decline coincides with the Treasury's increased borrowing efforts to rebuild its cash balance following the debt ceiling increase in July. This has drawn liquidity from other liability items on the Fed's balance sheet, such as overnight reverse repurchase agreement tools and bank reserves.

Now, as the funding for the so-called reverse repurchase tools is nearly exhausted, the reserves held by commercial banks at the Federal Reserve have been declining.

As the Federal Reserve continues to reduce its balance sheet (a process known as quantitative tightening), the movement of funds affects the daily operations of the financial system. Due to the potential for quantitative tightening to exacerbate liquidity constraints and lead to market turmoil, the Fed has slowed the pace of balance sheet reduction earlier this year, reducing the number of bonds it allows to mature each month.

The market generally expects that Federal Reserve officials will discuss the outlook for the balance sheet during their meeting in Washington next week. While a policy rate drop to 3.75%–4% is seen as highly likely, Wall Street is less certain about when policymakers will stop quantitative tightening—another tool the Fed uses to influence interest rates.

Strategists at JP Morgan and Bank of America expect the Fed to halt the reduction of its approximately $6.6 trillion balance sheet this month, thereby ending the process aimed at withdrawing liquidity from the financial markets. Both Citadel Securities and Refinitiv ICAP share the same view.

Federal Reserve Chairman Jerome Powell indicated last week that the reduction of the balance sheet would stop when bank reserves are slightly above the level that policymakers consider consistent with "ample" levels—the minimum required to prevent market turmoil.

He sent the strongest signal yet that the Fed currently believes this level is close, stating that the Fed may be "approaching this point in the coming months."

Money market rates continue to rise, although more cash has flowed into the front end this week, as government-supported enterprises deposit funds in repurchase agreements before making monthly principal and interest payments to mortgage-backed securities holders around the 25th of each month.

For strategists, the persistently high and volatile repurchase agreement rates indicate that reserves are no longer ample, and the financial system is approaching a state of scarcity