(Bloomberg) — Drawdowns from financial markets to cover this year’s tax payments bear close scrutiny as they risk pulling reserves to levels that could impact Federal Reserve’s efforts to unwind its balance sheet, according to JPMorgan Chase & Co.
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JPMorgan fixed-income strategists Teresa Ho, Holly Cunningham and Pankaj Vohra estimate that this year’s tax-related outflows could ultimately weigh on money-market fund assets and reserves, with the risk that the latter take a greater proportion of drawdowns as yields on bank deposits are less attractive.
As a result, the level of overall reserves, which now stand around $3.49 trillion, would drop to between $3 trillion and $3.275 trillion, according to JPMorgan — within the range deemed the lowest comfortable level by primary dealers surveyed by the Federal Reserve Bank of New York.
Maintaining adequate reserves is key to the Fed’s ongoing reduction of holdings on its balance sheet, a process known as quantitative tightening, or QT, with policymakers including Chair Jerome Powell indicating a slowdown soon to avoid ructions in funding markets. Also part of the equation are balances at the Fed’s overnight reverse repurchase facility, or RRP — a barometer of excess liquidity in the financial system, which are now around $474 billion.
“While we don’t necessarily think this will result in a funding crisis — given what we think will be a continued positive balance at the ON RRP in addition to the availability of the SRF — it could still be telling in terms of how far QT can continue to run as RRP reaches near-zero,” the strategists wrote in a Friday note to clients, referencing RRP as well as another Fed tool, the standing repo facility.
The impact of capital gains taxes are key to the anticipated drawdown in reserves, JPMorgan said. In 2022, individuals and corporates alike faced hefty tax bills given the steep run-up in financial assets the year prior; in 2023, the outflows were much more muted given the market’s performance.
JPMorgan strategists took each year as a boundary, tallying 2022 as a “worst-case” scenario and 2023 as a “best-case” for reserve declines. But as they noted, 2024 could be different — in part because money-market fund assets, enticed by attractive yields relative to deposit rates, could prove stickier than in past tax seasons. They see money fund assets dropping by $40 billion to $140 billion and reserve outflows totaling $215 billion to $465 billion.
After the release of the Fed’s rate decision last Wednesday, Chair Powell told reporters the central bank should begin tapering QT “fairly soon.” As usage of the RRP stabilizes at or near zero, Powell added, bank reserves should then decline on par with the central bank’s asset runoff.
At JPMorgan, strategists now see the Fed announcing the taper of its quantitative tightening program at the central bank’s next two-day meeting that ends May 1, with the start of tapering in mid-May. Balances at the Fed’s RRP falling to $300 billion by December.
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