Part 7/11:
The core debate revolves around whether the apparent liquidity crunch is a benign, technical adjustment—simply a transition from abundant to ample reserves—or a sign of systemic fragility. The Fed argues that the decline in bank reserves and the shift in reserves composition are normal parts of the balance sheet reduction process.
However, market signals suggest otherwise. The soaring repo activity and volatile rates imply that broader risk aversion is at play, possibly reflecting concerns about private credit markets, shadow banking, and collateral valuations. Investors and market makers are increasingly cautious, perhaps sensing vulnerabilities that are not purely technical.