It’s a crazy situation in which the Fed has argued as the liquidity tsunami goes haywire, the banking system suffers from less than $ 4 trillion in reserves, and the General Treasury account is withdrawn.
By Wolf Richter for WOLF STREET.
This morning, the Fed sold a record $ 485 billion in Treasury securities via overnight “reverse repurchase agreements” to 50 counterparties, breaking the previous record set on December 31, 2015. These overnight repurchase agreements next day will expire and take place tomorrow morning. Today, yesterday’s $ 450 billion in overnight reverse repurchases have matured and unwound, and have been more than replaced by this new batch of $ 485 billion in overnight reverse repurchases. on the next day.
Reverse repurchase agreements are liabilities on the Fed’s balance sheet. They are the opposite of pensions, which are assets. With these reverse repos, the Fed is sale Treasury securities go to counterparties and take their liquidity, thus massively draining liquidity from the market – the opposite effect of QE.
In recent years of significant reserves following QE, banks have paid reserves via reverse repurchase agreements, reducing balance sheet reserves and increasing their treasury holdings, to dress their balance sheets at the end of the quarter, and in particular at the end of the quarter. year. Reverse repurchase agreements declined after the Fed began to curtail its assets during quantitative tightening in 2018 and 2019. But the current record spike occurs in the middle of the quarter, a sign that the massive amount of liquidity is going haywire:
It’s a crazy situation that the Fed has backed down.
Even as liquidity goes haywire and the Fed tries to manage it through reverse repurchase agreements, the Fed still buys around $ 120 billion a month in treasury and mortgage-backed securities, adding liquidity. .
But with its $ 485 billion reverse repurchase agreements, the Fed canceled four months of QE!
The Fed could stop buying securities altogether and shrink its balance sheet, which would also drain liquidity from the market. But the Fed cannot do this because it has said it will be slow and deliberate in announcing changes in its monetary policy, and that it could possibly talk about tapering, so it cannot quite suddenly do an about-face.
But this hackneyed liquidity situation seems to be an emergency to be resolved now, and therefore the Fed treats it through the backdoor via reverse repos overnight.
At the same time, the Fed is pursuing QE. Its total assets were $ 7.90 trillion on its balance sheet as of May 26, released today, were down $ 19 billion from last week’s record, following the typical pattern. These assets include $ 5.09 trillion in treasury securities and $ 2.24 trillion in mortgage-backed securities (MBS):
The Fed discussed this liquidity issue at the last FOMC meeting and summarized some of the discussions in its minutes of meetings. He noted that “a modest volume of transactions” in the repo market has taken place at negative yields, which means there is so much demand for Treasuries, and so much liquidity chasing them. , that the cash holders were willing to lose money to get Treasury securities. This threatens to push down related rates, like the SOFR (Secured Overnight Financing Rate) which is the Fed’s benchmark rate to replace LIBOR.
The Fed, sitting on $ 5.09 trillion in treasury securities, has entered the reverse repo market, selling treasury bills overnight to meet this demand for treasury bills and prevent yields. to meander below zero.
The liquidity tsunami.
Everyone has their own theory as to why there is so much demand for Treasury securities. But one thing we do know: The banking system is creaking under a huge amount of liquidity.
Bank reserves on deposit with the Fed – a liability on the Fed’s balance sheet, money the Fed owes banks and on which it currently pays 0.1% interest – hit a record 3.98 trillion dollars on April 14 and have since zigzagged. down a strand. On the Fed’s balance sheet released today, they were at $ 3.81 trillion. This is a sign of how much liquidity banks are swimming in:
Withdrawal from the general treasury account.
The government sold a gigantic amount of debt last spring, adding $ 3 trillion to its debt in a matter of months, and kept the unspent amounts in its checking account – the General Treasury Account or GTA at the Fed, which is a liabilities for the Fed, the money it owes the US Treasury. The GTA balance climbed to $ 1.8 trillion in July 2020, from the pre-crisis range of $ 100 billion to $ 400 billion.
The Mnuchin Treasury started spending the current account balance by borrowing a little less. By early January, the GTA had fallen to $ 1.6 trillion.
Treasury Yellen formalized the levy and announced in early February that it would reduce the balance to $ 500 billion by June. It turned out to be too quick and it now looks like August will be the month when the levy hits the $ 500 billion mark.
On the balance sheet released today by the Fed, the balance as of May 26 had fallen to $ 779 billion. Down $ 821 billion since February, $ 279 billion to spend:
The GTA levy has certain implications for the markets: it is money the government will spend but not tax or borrow; he already borrowed it from March to June of last year. And the Fed has paid off that debt with its $ 3 trillion in asset purchases. So the pullout means the government spent that money the Fed had already monetized in the spring of last year.
All of this has big implications for the markets. These are huge amounts, in terms of reserves on deposit at the Fed, the drawdown of GTAs at the Fed, and now the reverse repurchases at the Fed, all liabilities at the Fed, all representing different aspects of the massive flows. cash now bouncing off the walls.
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