Yahoo Finance Key Fed Metric on Bank Reserves Gives Mixed Signals on Liquidity
(Bloomberg) -- A key Federal Reserve indicator of scarcity of cash in the financial system is grabbing a lot of attention from market participants who are on the lookout for any evidence of stress.
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Historically, the peak level of daylight overdrafts — when a bank withdraws more money than it has in its account at the Fed to make a payment – tends to move in the same direction as the average level. But last week’s reading showed the data points are no longer in sync: peak levels increased for the second quarter in a row, while the average level moved toward the low end of its recent range. While such a spike in peak daylight overdrafts is usually a warning sign of reserve scarcity, this time it may be different, according to Wrightson ICAP senior economist Lou Crandall.
“It is at least possible that the surge in peak usage of intraday Fed credit will turn out to be a positive,” Crandall wrote in a note Monday. “We’re reluctant to draw strong conclusions from the latest data, as we don’t know exactly what is driving the trend.”
New York Fed’s Roberto Perli echoed that sentiment last week at its 10th annual US Treasury Market Conference, noting that there are “other measures of reserve adequacy that show bank reserves remain “deep inside the ‘ample’ range.”
Perli, who oversees the central bank’s portfolio of assets, said in remarks that average overdrafts were a better gauge of frictions at this point, but said officials are watching peak levels to determine the point at which bank reserves start to become scarce.
Some banks may have become more tolerant of spikes in daylight overdrafts as part of the Fed’s push to make its various liquidity backstops more effective, according to Crandall. The central bank in 2022 made technical adjustments to streamline the administration of the overdrafts program, though those were targeted at smaller institutions “and probably didn’t play a role in this year’s sudden run-up,” he added.
Just as regulators are trying to get banks more comfortable using the discount window — the Fed’s principal emergency lending facility — on a regular basis to ensure they can quickly respond in the event of a financial shock that might trigger a rapid flight of deposits, banks may do the same with daylight overdrafts, Crandall said. So far, banks have been reluctant to turn to the discount window fearing it would be perceived as a sign of weakness or desperation.
Michael Barr, the Fed’s vice chair for supervision, said at the same New York Fed conference on Thursday, that last month the central bank issued a request for information about the operational aspects of Fed extensions of both the discount window and intraday credit.
The bottom line is if the average level of overdrafts associated with interbank payments over the course of each session consistently climbs in the coming quarters, Crandall said the current trend could be compared to 2019, when an increase in government borrowing and a corporate tax payment created a shortage of reserves. That resulted in a five-fold surge in a key lending rate and a spike in the federal funds rate above the target range, forcing the Fed to intervene to stabilize the market.
Yet, “if some banks are in fact more willing to rely on their Fed overdraft privileges to meet intraday working-balance needs, they may be less inclined to hoard reserves going forward,” Crandall wrote. “That ultimately could allow the Fed to shrink its balance sheet more than would otherwise be the case.”
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