Fed Reverse Repo Facility Nears $1 Trillion In Use, Debt Ceiling Deadline Complicating Treasury Markets
Fed Reverse Repo Facility Nears $1 Trillion In Use, Debt Ceiling Deadline Complicating Treasury Markets
There has been some anomalous behavior in treasury markets lately, perhaps best exemplified by the record set Wednesday when a total of $992 billion was parked in the Fed’s Reverse Repo facility where counterparties like large MMFs and other big market participants can park their cash with the US Central Bank. On Thursday, the reverse repo volumes inched off their successive highs on Tuesday and Wednesday and fell to around $742.6 billion on Thursday and $731.5 billion today.
While the Reverse Repo facility filling up may have an ominous sound to it, if banks were concerned about excessive outflows to the Fed at their expense, they could always raise the rate they offer to retain the business.
The demand for the Fed’s specialized facility has been dramatically increasing since one of the more obscure actions from their recent meeting when they raised the offering rate to 0.05% from 0% in response to the flood of liquidity beginning to eclipse the capacity of funding markets for the US dollar. Several activities of the Fed that follow under the umbrella of quantitative easing are pushing a large amount of reserves into the system.
We mentioned that these rate rises were counterintuitive when the Fed did them because, despite raising a technical rate, the effect of the action was accommodative and in the end is an open-market operation designed to keep the Federal Funds rate within the committees preferred range.
One additional factor that is more fiscal in nature, but nonetheless may be influencing the Fed is Treasury Department which heavily incentivized to reduce its cash balance ahead of the impending political Kabuki around the US debt ceiling. This additional source of liquidity in a market already awash with it might be causing price discovery to be distorted in short-term rates and money market funds. So, the fiscal may be bleeding into the monetary, a theme which we will continue monitoring as the US Central Bank continues navigating the most significant challenge it has faced perhaps since the dual mandate forever altered its role in the system of American governance.
This is being complicated by the upcoming debt ceiling deadline as the Treasury General Account, which is deposited at the Fed, needs to be reduced to a $450 billion target, down from a June 29 balance of $711 billion, before the two-year debt ceiling suspension expires on July 31st. The current political environment and our assessment from Washington expert Tom Block suggests this will be a painful process fraught with potential headline risk.
There’s been discussion among some Fed officials about mitigating the purchases of mortgage-backed securities (MBS) as readings from the housing market are elevating concerns that the $40 billion a month in purchases could be causing perverse effects and pricing in housing markets.
Despite the highest readings on many housing indicators since the eve of the mortgage crisis, like the 11.3% YoY increase in the CoreLogic home price gauge, Fed officials don’t see the financial stability concerns due the nature of demand now compared to 2008. Credit quality of borrowers remains much more solid then in the runup to the GFC.
Asset purchases continued at a pace of $40 billion a month for MBS and $80 billion a month for Treasuries. The benchmark yield on the 10 year is 1.431%.
