(Bloomberg) – US dollar denominated finance markets are already facing a myriad of challenges that are distorting supply and demand, and those effects will only intensify as the US government’s legal credit limit returns.
Short-term dollar borrowing rates were cut to zero and below, weighed down by purchases of Federal Reserve assets, drawing on the US Treasury’s huge stash of cash, and a shift from bank deposits to money market funds. The reintroduction of the debt ceiling, suspended in 2019, in late July threatens to exacerbate that dynamic as its return also affects how much cash the Treasury Department can legally hold.
The reinstatement will force the Treasury Department to reduce its cash balance to levels close to the previous suspension, or about $ 120 billion to $ 130 billion from the current $ 924 billion. That would bring more cash to the market and at the same time pull the bill payment offer out of the market.
While JPMorgan Securities strategists Teresa Ho, Alex Roever and Ryan Lessing estimate that the gap between supply and demand is currently around $ 585 billion, there is room for that to widen.
“Too much money”
Either way, there is too much money to buy a home for and not enough products to invest in, and that’s what makes it all tight, “said Gennadiy Goldberg, senior US interest rate strategist at TD Securities. The debt ceiling “will only add to the Treasury headache.”
The longer these idiosyncrasies persist, the more the Federal Reserve will be forced to step in to maintain control over the short end – especially over its central political goal, the federal effective interest rate. The Fed appears to be already taking steps by changing the mechanics of its reverse repurchase agreement facility overnight.
Last month, the Fed instructed the Federal Reserve Bank of New York to raise the counterparty limit on the overnight repo facility (O / N RRP) from $ 30 billion to $ 80 billion. This could help prevent short-term interest rates from sliding any lower. The move was well received, and adoption quickly rose to its highest level in almost a year.
The story goes on
Lorie Logan, executive vice president of the New York Fed, said in a speech on April 8 that the bank could adjust the licensing requirements for its day-to-day operations to allow wider involvement of the fund community.
Policy makers still have the option to tweak the Fed’s rates on the excess reserve interest rate, the offered level of the O / N EIA, or both. In the minutes of the March Federal Open Market Committee meeting, Chairman Jerome Powell pointed out the potential for downward pressure on money market rates and suggested that it might be “appropriate” to make adjustments at upcoming meetings or even between meetings to ensure that the Fed Funds rate remains “well within target range.”
The latest FOMC minutes suggest that the Fed recognizes that the overnight repo rate is a “more important operational parameter than the IOER is at present,” Wrightson’s ICAP economist Lou Crandall wrote in a note to clients. Wrightson believes that any initial adjustment to the O / N MSRP – and possibly the IOER – would be 2 basis points, while the second choice is a 3 basis point optimization.
The fact that the FOMC “lays the groundwork for a possible adjustment so explicitly” reinforces the belief that the Fed will react faster than in the past to the technical downward pressure on overnight rates, Crandall wrote.
JPMorgan strategists, who said in February that the Fed would not have to make adjustments to their instruments by mid-year, now say policymakers could optimize earlier. You are not alone with such thoughts.
“It is certainly on the Fed’s radar that the pressure is mounting,” said Goldberg of TD. “You want to make sure that the levy at the lower end of the target range is strong enough to stem this cash flow.”
(Updates, including the recent inclusion of the Fed’s streamlined operations in the seventh paragraph.)
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