Federal Reserve tightening could strain markets in 2024 as key liquidity buffer declines

The Fed has been running quantitative tightening (QT) to reduce liquidity, but money market funds (MMFs) have released pent-up liquidity which has offset the impact so far.

MMFs have drained down their reverse repo (RRP) balances and bought T-bills, sterilizing the impact of the Fed's QT.

The RRP buffer has fallen from $2+ trillion to $600 billion, so this sterilization mechanism may end in 2024.

Declining liquidity could strain the repo market, cause issues for leveraged players, and spur deleveraging.

This is an underestimated risk that could cause problems in 2024 as the Fed continues QT but the offsetting MMF liquidity buffer declines.