Five years later, the dynamics of the Federal Reserve's balance sheet are still very important.

Noted, as the Federal Reserve continues to shrink its balance sheet, it still faces the same problems that it faced over five years ago. Although market dynamics have changed, the main challenge for policymakers and investors is how to gauge the liquidity of the financial system and avoid turbulence that could force the Federal Reserve to intervene in September 2019 when it reduces its asset holdings. Since the mid-2022 launch of quantitative tightening policies, the Federal Reserve has reduced over $2 trillion in assets. Now, considering levels of reverse repurchase agreements (a measure of excess liquidity), almost emptiness, and other factors like bank reserves, many Wall Street strategists expect the Federal Reserve to end its quantitative tightening policy in the first half of this year. They also point out that recent turmoil in the repurchase agreement market (most notably at the end of September) was not a result of Federal Reserve actions, but may be a result of actions in 2019. Deutsche Bank strategist Steven Zeng stated: "Things may have changed since then, especially with the much larger scale and issuance in the U.S. Treasury market." The ability of traders to act as intermediaries in the market is limited, which is a "key difference as repo volatility is greater than reserve scarcity, which may be a critical distinction." Back in 2019, quantitative tightening led to reserve scarcity, combined with factors like significant corporate tax payments and settlement of Treasury auctions, resulting in liquidity tightening, causing key lending rates to spike, prompting the Federal Reserve to intervene to stabilize the market. Even now, the threshold of reserve scarcity is still unclear, but officials say it is the lowest comfortable level for banks plus a buffer. Current balances are at $3.33 trillion, which officials believe is ample, approximately $250 billion lower than the level when reserve reductions began two and a half years ago. For some market participants, the lack of a decrease indicates that institutions' ideal reserve levels are much higher than expected, with some banks actually paying higher financing costs to hold onto cash. The latest survey of senior financial officers released by the Federal Reserve last month showed that over one-third of respondents are taking steps to maintain current levels. Debates about adequate reserves and the termination point of quantitative tightening policies are not new. At a January 2019 meeting, then-Federal Reserve Governor Lael Brainard warned against seeking the steep part of the demand curve for bank reserves, saying it would "inevitably lead to increased volatility in funding rates" and that "new tools would be needed to contain this situation." Brainard later pointed out at subsequent meetings that the end of Federal Reserve quantitative tightening policies may coincide with fluctuations in reserve levels due to nearing debt ceilings, adding that reserve levels could differ significantly from normal balances. Time has passed, and concerns about uncertain reserve prospects due to debt ceilings have arisen again. In the latest meeting minutes from December 17 to 18, open market account manager Roberto Perli mentioned, "The debt ceiling may return in 2025, leading to significant changes in the Federal Reserve's liabilities, which could pose challenges in assessing reserve conditions." Since discussions in 2019, a notable development has been the establishment of the Standing Repo Facility (SRF), launched in July 2021. Eligible banks and primary dealers use SRF to borrow money overnight in exchange for U.S. Treasuries and agency debt, becoming a source of liquidity. By offering financing at rates set by the Federal Reserve, the goal is to ensure that the federal funds rate does not exceed the central bank's policy target range. At a June 2019 meeting, Federal Reserve Chairman Jerome Powell saw two potential attractions of the SRF: avoiding spikes in the federal funds rate and keeping bank reserve sizes as small as possible. However, as bank activity pushed up funding rates at the end of the quarter on September 30, balances jumped to only $26 billion, the highest level before daily operations became permanent, indicating that the tool is still underutilized. The Federal Reserve recently added early morning operations to further support market participants. The main criticism of the tool is that it is not centrally cleared, so any activities will increase balance sheet costs. This circles back to the constraints faced by dealers and their ability to act as intermediaries in the market. Deutsche Bank's Zeng stated, "Discussions from 2019 are likely to influence their views on the SRF to some extent today." At that time, "they believed that excessive and frequent use of the SRF could lead to adverse outcomes, they were concerned about moral hazards similar to all liquidity support mechanisms."