Basel Liquidity Rules Block Fed’s QE Exit
By Kris Devasabai
After flooding the market with liquidity for the better part of a decade, the US Federal Reserve has begun tightening the spigot. Over the next five years, its asset portfolio will shrink by as much as $1.9 trillion as a result of ‘balance sheet normalisation’, which startedin October 2017. This reduction in the Fed’s balance sheet assets must be matched on the liability side by a decline in reserve balances, which banks maintain for liquidity purposes. … But as the Fed drains reserves, and the Fed funds rate moves closer to IOER, the arbitrage becomes less attractive. “The foreign banks are typically holding reserves because they can fund them at a lower rate than IOER,” says Josh Younger, head of US interest rate derivatives strategy at JP Morgan. “For them, it’s an arbitrage, and they’re already winding down those books.” As a result, Younger expects foreign banks, which had $967 billion of cash at the Fed as of January 10, to “bear the brunt of early-stage reserve draining”. New senior management guidance proposed by the Fed on January 11 – which would require foreign banks to show they are operating their branches and agencies in accordance with US capital requirements – could hasten the process. “That’s a quiet way to end the arbitrage,” says Karen Petrou, managing partner at Federal Financial Analytics, a Washington, DC-based consultancy, which flagged the proposal in a note to clients.
https://www.risk.net/regulation/5443286/basel-liquidity-rules-block-feds-qe-exit