There’s still a ~$1 trillion question hanging over markets: How much Treasury issuance will ultimately be absorbed through RRP transformation?
The “debt ceiling resolution as a bear case” narrative was poorly understood by many investors due to the somewhat esoteric dynamics involved.
Treasury’s post-deal cash rebuild would flood the market with bills, and there was no guarantee the majority of that supply would be mopped up by cash parked in the Fed’s repo facility. Uncertainty around the terminal rate (i.e., the prospect of more rate hikes, and thereby higher RRP rates) introduced additional risk.
In short: It was possible (and still is) that a sizable share of Treasury’s funding needs will drain reserves as opposed to RRP. When taken in conjunction with Fed QT, there was a reasonably compelling liquidity bear case headed into summer. It sounded even more convincing when you factored in ECB QT, TLTRO repayments across the pond and the resumption of student loan payments in the US.
Again, some of that (most of it) is Greek to everyday people who, lacking the wherewithal to develop an informed opinion, just assumed the worst. As it turns out, that wasn’t a safe assumption. “Just” $1.728 trillion was parked in the RRP facility Monday, a continuation of the recent drain. At the same time, receding expectations for the second of the two Fed hikes implied by the June dot plot have seemingly bolstered demand for bill auctions.
RRP usage, now the lowest since April of 2022, may rebound early this week, but nevertheless, the point is that worst-case fears of reserve drain dominating RRP drain vis-à-vis Treasury supply haven’t materialized. With that in mind, the figures below from Morgan Stanley are useful. You can easily recreate them and tinker with them if you like. It’s just Fed and Treasury data.
As the bank’s Efrain Tejeda wrote, RRP had dropped by $413 billion as of late last week from the debt ceiling resolution, a figure which “represent[ed] 65% of new T-bill supply being used to rebuild the TGA and finance government spending [and] 75% of the TGA increase so far.” The impact to reserves was just $125 billion.
As the bank wrote, that suggests “clear downside risk” to Morgan’s $1.7 trillion RRP forecast for end-Q3. Again, RRP usage was barely more than that on Monday. And it’s not even August yet. But the bank still expects reserves to head “gradually” lower over the third quarter to around $2.8 trillion in light of QT and dwindling Fed bridge loans to the FDIC.
Tejeda offered some key nuance. The drop in RRP isn’t explained fully by money market funds. Rather, “FHLBs have likely used RRP cash to pay down debt outstanding” amid reduced emergency liquidity needs from banks, who can anyway access the Fed’s BTFP facility. “This has contributed to almost 40% of the RRP decline in June and likely pushed MMFs into T-bills as supply of FHLB debt turned negative,” Tejeda went on, noting that “the significant decline in FHLB debt supply made the decision to purchase bills ‘easier,’ as MMFs were substituting between assets with similar duration.” Should that dynamic reverse going forward, demand for bills could wane.
For what it’s worth, Morgan is sticking with their RRP call for now, but the bank acknowledged that recent declines “are likely to keep concerns around reserve scarcity at bay.”
Related: Money Market Funds Back To Outflows. RRP Lowest In 15 Months
