The Federal Reserve Bank of New York's inaugural monthly indicator suggests that the U.S. banking system's reserves remain ample, indicating that the Federal Reserve can continue quantitative tightening.

A new indicator launched by the New York Fed on Thursday shows that the Federal Reserve is not facing imminent market liquidity challenges that would prevent the ongoing contraction of its balance sheet.

This new indicator, dubbed "Reserve Demand Elasticity" (RDE) by the New York Fed, aims to measure the liquidity of bank reserves. The Fed stated that it would help Federal Reserve officials better manage the uncertain process of reducing bond holdings, known as quantitative tightening (QT).

The purpose of establishing this new indicator is to serve as an early warning sign of a shortage of bank reserves. The New York Fed said in a blog post that the indicator would help identify the transition point where liquidity moves from an ample level to a "sufficient" level. The "sufficient" level of reserves that policymakers refer to is often difficult to determine.

Data available as of October 11 indicates that "reserves are still ample." The latest RDE estimate is close to zero, which means that the federal funds rate will not respond significantly to changes in the supply of reserves. As a reference, a negative RDE reading would indicate a tightening of liquidity.

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The Federal Reserve's QT process has been ongoing for over two years, reducing its balance sheet total from a peak of $9 trillion to the current level of $7.1 trillion. Following the COVID-19 pandemic, the Federal Reserve is seeking to withdraw unnecessary liquidity as part of monetary policy normalization.

The Federal Reserve wants to ensure that there is enough liquidity in the financial system to firmly control the federal funds rate, which is the primary monetary policy tool the Federal Reserve uses to influence the economy. However, the challenge for officials is that it is currently unclear when liquidity will become too scarce to cause turmoil in money market interest rates.

Earlier this year, the Federal Reserve slowed the pace of QT to make it easier to identify any imminent liquidity challenges before they become apparent. This is because officials are wary of the turmoil caused by the last QT, when liquidity unexpectedly tightened in September 2019, forcing the Federal Reserve to intervene and add liquidity to the market.

Federal Reserve officials have indicated that they expect the QT plan to continue for some time. Prior to the Federal Reserve's September policy meeting, market participants expected this process to stop in the spring.

At the end of September, just before entering the fourth quarter, the level of turmoil in the money markets was sufficient for some market participants to speculate that the Federal Reserve might need to end QT early. However, St. Louis Fed Chairman Musa Lham in his comments on October 7 noted that the federal funds rate has been "well controlled" for some time, implying that recent fluctuations will not affect the outlook for QT.So far, the process of the Federal Reserve's QT (Quantitative Tightening) has primarily involved draining cash from the reverse repurchase agreement tool. This year, the usage of the Federal Reserve's reverse repo tool has significantly decreased.

In the meantime, the collective reserve levels of banks have remained virtually unchanged for a considerable period. Most observers believe that the Federal Reserve will be able to continue implementing QT before they start to decline.

The Federal Reserve Bank of New York has noted that the RDE (Reserve Deficiency Estimate) was negative well before the troubles in September 2019, indicating that the new metric can help officials gain a good understanding in advance of when reserve shortages might occur, thereby challenging their control over the federal funds rate.

Analysts from the investment bank Barclays have stated, "We expect bank reserves to remain slightly above the 'ample' threshold by year-end." They continue to anticipate that the Federal Reserve's QT will conclude this year, ahead of the expectations of many other traders and investors.

The Federal Reserve Bank of New York has stated that it will update the RDE readings at 10 a.m. on the third Thursday of each month, Eastern Time, except for Federal Open Market Committee (FOMC) meeting dates.