Core Viewpoints - The Federal Reserve's balance sheet reduction is ongoing but has slowed down, leading to liquidity in the financial system approaching a critical threshold [2][6] - Recent signs of tension in the repurchase market and increased volatility in funding rates raise concerns about potential severe liquidity shocks [6][10] Group 1: Liquidity at a Critical Point - U.S. liquidity is diminishing as the Federal Reserve continues its balance sheet reduction, with the overnight reverse repurchase (ON RRP) balance dropping to $5.48 billion as of October 15, down from $2.5 trillion at the end of 2022 [6][10] - The secured overnight financing rate (SOFR) experienced a significant spike on September 15, indicating tightening liquidity conditions [6][10] - The reduction in liquidity is attributed to the rebuilding of the Treasury General Account (TGA), which absorbed approximately $140 billion in liquidity during the week of September 17 [10][11] Group 2: Will a "Liquidity Crunch" Reoccur? - The likelihood of a liquidity crunch is low, as bank reserves are expected to decrease but remain above critical levels [3][22] - The next significant influx of tax revenue into the TGA is anticipated in April, which may coincide with a slowdown in Treasury issuance [3][22] - Despite the depletion of excess liquidity, SOFR may remain elevated, but conditions similar to the 2019 liquidity shock are not expected to recur [22] Group 3: When Will Balance Sheet Reduction Stop? - The balance sheet reduction process is likely to continue unless unexpected events occur, with the Federal Reserve expected to halt reductions when reserves are slightly above adequate levels [4][24] - Estimates suggest that the appropriate level for bank reserves is around $2.7 trillion, which may be reached by mid-next year if the current pace of reduction continues [4][24] - Even if a liquidity crisis occurs, the Federal Reserve has tools to provide temporary liquidity and may consider slight balance sheet expansion to support the market [26]