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Liquidity Crisis Approaches

The Fed’s balance sheet took a big jump last week as settlements of forward MBS purchases more than offset reductions in the alphabet soup programs being shut down as well as the little noticed roll off of some maturing GSE paper. GSE maturities totaling $29 billion over the next year will play a small role in reducing the size of the Fed’s balance sheet and draining systemic liquidity. Playing a bigger role will be the fact that the Fed will completely end its GSE purchases on March 31, and will complete the settlement of its MBS purchases in June, with those settlements gradually diminishing in April and May.

The ending of the GSE and MBS purchases will put the Primary Dealers under intense pressure as they continue to face enormous waves of Treasury supply. They will need to liquidate something. We’re already seeing signs that they are derisking and deleveraging, in the beginning of a downturn in their corporate bond holdings and the covering of some of the T-bills that they had used to fund carry trades.
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