A day ahead of what's expected to be very volatile conditions in money markets, a top Federal Reserve Bank of New York official said on Monday that markets are still flush with liquidity, central bank tools are in place to manage temporary hiccups, and in any case some level of chop in money market rates is healthy.

“Our indicators currently suggest that reserves are still abundant,” said Julie Remache, who is deputy manager of the bank’s System Open Market Account and Head of Market and Portfolio Analysis. Her comments indicate she does not see a looming need to end the process of shrinking Fed holdings in an effort called quantitative tightening, or QT. But the official did note there’s been some “firming” of repo rates of late, and that ongoing QT may lead to keeping those rates up over time.

Remache spoke just ahead of what is likely to be heavy volatility in money markets tied to the quarter end. Those periods are often associated with shortages of liquidity and higher money market rates as firms manage their holdings for end-of-quarter reporting requirements or other purposes. Quarter-end pressures usually abate in short order but the current period is more fraught due to Fed actions.

Since 2022, the Fed has been allowing a set amount of bonds it owns to mature and not be replaced as it seeks to remove from the financial system the ocean of cash it added to markets to stabilize trading and stimulate the economy during the COVID-19 pandemic and its aftermath. Fed holdings more than doubled to a peak of $9 trillion and have since ebbed to $6.7 trillion.

Thus far, the contraction of liquidity has primarily taken out cash that markets did not need, and is reflected in the fact that from a peak of $2.6 trillion at the end of 2022, the Fed's overnight reverse repo facility has in recent weeks shrunk to negligible levels. As QT moves forward it will now start to remove what have been steady levels of reserves, which increases the chance of unexpected pressure in the market.

With the QT process now eating into underlying levels of liquidity, markets are actively speculating about how much further the process can go on. They're also expecting Fed liquidity facilities to get big action on Tuesday. Wrightson ICAP has penciled in as much as $300 billion in reverse repo inflows as market participants look for a short-term parking place for cash.

What will be more notable is what happens with the Standing Repo Facility, or SRF. Created in 2021 to provide fast cash in exchange for bonds, this Fed tool is designed to be a short-term shock absorber for liquidity shortfalls, allowing the Fed to keep its eye on longer-term trends when pressing forward with QT. The SRF also allows the Fed to shy away from interventions in markets to manage liquidity.

The challenge is that thus far, the SRF has seen little real-world usage. That's almost certain to change on Tuesday. Wrightson sees potential inflows of around $50 billion.

In her speech, Remache cautioned that the Fed will not be surprised by potential churn. She said that even though the central bank’s rate control is working well and strongly influencing the setting of interest rates generally, “money market rates still vary, and tend to rise on key reporting dates, including quarter ends, as banks optimize their balance sheets.”

This firming of rates around the quarter end “is - within limits - normal, not concerning, and exactly what we expect as we continue to normalize our balance sheet.”

On the SRF, Remache said the facility “can stem incipient rate pressure that, if left unaddressed, could threaten rate control.”