I got a great question yesterday from Aaron, a longtime Liquidity Trader subscriber.
He referred to a post in Zero Hedge, which in its inimitable, breathless and incomprehensible fashion referred to a looming crisis in the Fed’s Reverse Repo program.
This is an important issue, but there’s a lot of confusion around it, so I want to try to explain exactly what’s going on and why it’s not a crisis now, but is a mirror on a process that will lead to one. We know exactly why, and we know when.
Aaron wrote:
Hi Lee,
I was wondering if you might comment on the rapid rise in reverse repos in your next Liquidity Trader report. I assume you are aware of what’s been happening in the repo market, but in case you aren’t, here is a link:I am not a huge fan of Zerohedge’s politics, but most of their financial reporting is accurate. This information seems to jibe with what you have been reporting for several months. Could this be why stock markets have been shaky even though the treasury has been so generous with pay downs and the Fed has maintained the same level of QE?kind regards,Aaron
Hi Aaron-
Thanks for your question!
Sure. It’s from the T-bill paydowns. The Treasury has removed a couple hundred billion in T-bills from the market in recent weeks, pumping cash into dealer, bank, money market fund, and other institutional accounts, as well as foreign central banks forced into RRP because they can’t recycle their T-bills.
I will interject here that the Treasury is paying down T-bills because it has been sitting on a pile of cash that it built up by selling excess Treasury debt to fund the pandemic programs way back last April and May. That cash pile at one point last year hit $1.8 trillion, and they kept it at $1.6 trillion or so until February.
But they have a problem with that because the 2018 budget law requires the Treasury to hold no more than $133 billion in cash by this August. The Treasury has been spending fast, obviously, but hasn’t cut back on its coupon issuance. Part of the reason it hasn’t whittled down its cash faster is skyrocketing withholding tax collections since March (which by the way, prove that the BLS jobs report for April was wrong). We cover that in real time.
With all that tax revenue coming in, and a legal mandate to get cash levels down A LOT in the next couple months, the Treasury has a problem. It needed to find a way to get rid of all that excess cash.
To do that, it has resorted to massive Treasury bill paydowns. Normally, when outstanding T-bills mature, the Treasury just reissues them and holders roll them over. But now, instead of reissuing them, the Treasury is redeeming them. It is actually giving the holders of the expiring T-bills their money back. Cash on the barrel head. The erstwhile holders of the bills are now stuck with billions and billions and billions in cash, more and more, week after week.
The Treasury started this on February 23, and in recent weeks has picked up the pace of paydowns to $40 billion per week. This week they are upping that to $44 billion.
I’ve covered this process in depth in Liquidity Trader reports to subscribers, so I continued in my response to Aaron.
With a shortage of paper to roll into, they have no place to go with it. While some holders use the cash to buy longer maturity Treasuries, rather than leaving it in deposit reserve accounts at the Fed, many of these investors and dealers shift the cash to overnight RRP. This is still absolutely liquid money. It’s just called something different than “reserves.”
And about 2/3 of it is foreign central bank holdings. That will sit there until the Treasury starts issuing bills again.
I’ll go over this again in my next Fed balance sheet update. See page 5 in this report.
In my view, the buildup of cash in the RRP line item is a source of bullish liquidity and not a reason why the markets have been shaky. I don’t know the answer to that question, but I suspect it has something to do with over-speculation and excess leverage in cryptos and meme stocks.
As always, the why is less important than the what.
And I still view the most important “what” as this immense buildup of cash. It’s incendiary, in my view. But it’s also finite in time. We know that it will end when the Treasury runs out of it, which will probably happen in XXXX (for Liquidity Trader subscribers). At that time, when the Treasury starts issuing T-bills again, the RRP line item will go back to near zero.
I disagree with your characterization of Zerohedge and caution you about placing any reliance on it. Their characterization of the shift to RRP as a crisis is silly, although it does presage a crisis. The crisis will be when those holding the RRPs shift the money back into T-bills. But the entire spectrum of Fed policy will have led to it, not just the RRPs, which are actually irrelevant. If the RRP program did not exist, the money would have simply gone into the reserve account.
Feel free to send follow up questions. I’ll publish a version of this for free since I can guarantee that you are not the only person wondering about this.
Thanks for your support!
Lee
