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The Fed is still shrinking its balance sheet, however, and we have reached the point at which the Fed’s reverse repo program (RRP) has been all but depleted. That means that any further reductions in assets will likely start shrinking bank reserves (which would constitute a proper tightening of policy). However, with the Treasury’s cash balance at the Fed (TGA) at a robust $830 billion, any spending down of that TGA balance during the “extraordinary measures” phase of the debt ceiling process could neutralize that tightening. The long-term chart below shows that the Fed’s balance sheet still has a long way to go before reaching more normal levels. At 23% of GDP, it is well below the 36% extreme set during Covid, but well above where it was during the pre-QE days.

The chart below shows the change in these three components of liquidity from the start of the Fed’s tightening cycle. Reverse repos have completely offset the Fed’s balance sheet contraction. /3