The reserves of the Bank of America system have fallen below 3 trillion USD, the lowest level since October 2020, which is an important indicator concerning the Fed's decision to continue reducing its balance sheet.

Data released by the Fed on Thursday showed that as of the week ending January 1, bank reserves decreased by about 32.6 billion USD, to 2.89 trillion USD. This is the largest weekly drop in two and a half years.

This decline comes as year-end circumstances force banks to reduce balance sheet-intensive activities, such as repurchase agreement trades, to strengthen accounts to meet regulatory requirements. This means that capital is flowing to places such as the Fed's overnight reverse repurchase tool, pulling liquidity from other liability categories of the Fed. From December 20 to December 31, the overnight reverse repurchase agreement tool (RRP) balance increased by 37.5 billion USD, dropping 23.4 billion USD on Thursday.

Meanwhile, the Fed has also been withdrawing excess cash from the financial system through its Algo tightening plan, while Financial Institutions continue to repay loans from the bank's term funding program.

As USA decision-makers continue to advance Algo tightening, Wall Street strategists have been closely watching reserve levels, with some estimating that the lowest point, including buffers, is between 3 trillion and 3.25 trillion USD. Policymakers indicated in last month's meeting that they will continue to shrink the balance sheet.

Decision-makers have also adjusted the issuance rate of the RRP tool to align with the bottom of the federal funds rate target range. This has put downward pressure on short-term rates, and some believe it may be enough to sustain the situation of reduced availability of principal for a while longer.

However, debates are intensifying regarding how long the Fed can maintain its Algo tightening plan without evoking memories of September 2019. At that time, as the Fed shrank its balance sheet, reserves became too low, leading to a cash shortage that caused key loan rates and federal funds rates to soar. The Fed later had to intervene to stabilize the market.

The Fed has started reducing the monthly cap on US Treasury securities that are not reinvested since June, but it remains unclear when this plan will be completely concluded.