With interest rates rising rapidly, quantitative tightening (QT) by the U.S. Federal Reserve is also cutting liquidity in the U.S. banking system and pressuring deposits — trends that may ultimately weigh on economic growth, says Fitch Ratings.
In the years leading up to, and including, the pandemic, the Fed engaged in repeated quantitative easing, which sharply boosted liquidity in the U.S. banking sector, the rating agency said.
However, as the Fed reverses that stance, banks’ reserves are falling, and deposits are dropping too.
“Deposits peaked at US$18.1 trillion in April 2022 — just before the Fed started QT — and had fallen to US$17.4 trillion by March 2023,” Fitch reported.
“This fall is almost without precedent,” it said, and it came despite loan growth remaining robust, pushing up the loan-to-deposit ratio.
These tighter financial conditions are expected to ultimately lead to slower economic growth.
“Tightening banking system liquidity could, in turn, result in more restrictive credit conditions if increased competition for deposits puts upward pressure on bank funding costs or makes banks less willing to lend,” it said. “This could weigh on U.S. economic growth.”
While overall liquidity indicators are still sound, Fitch said that it’s forecasting bank reserves to drop by US$900 billion to US$2.5 trillion by the end of the year.
And, it said that reserves could fall even faster than expected, which would further tighten credit conditions and weigh more heavily on growth.