As noted here last week, not all market participants have reason to concern themselves with the MMF-RRP-T-bill-reserve nexus.
It’s a somewhat esoteric discussion. I wouldn’t call it “irrelevant” for everyday people, but I would submit that for the vast majority of investors, staying apprised of the latest developments on this front isn’t the best use of time, unless you’re simply interested in arcana for the sake of it.
As a quick aside, I wouldn’t be where I am today (and sometimes I’m not entirely sure where that is) if it weren’t for my own interest in arcana for the sake of it once upon a time, so I wouldn’t want to discourage anyone who’s similarly inclined. All I’m saying is that it often feels like the financial media’s profit motive manifests in a zeal for monetizing the mysterious. In markets, esoteric topics are synonymous with mystery. You can build an entire mythology around yourself simply by offering laypeople a window into such topics — just ask Zoltan Pozsar.
All of that said, I’ve obviously spent an enormous (probably inordinate) amount of time editorializing around the interplay between money market funds, the Fed’s RRP facility, Treasury’s cash rebuild, reserves and QT. Suffice to say a worst-case scenario defined by stubborn RRP balances and rapid reserve drain amid Treasury’s post-debt ceiling supply tsunami was averted. Notwithstanding a temporary leveling off of RRP last month, the situation has developed more in-line with a best-case scenario.
Long story short (and this is familiar territory for the “professionals” among you), RRP transformation has, at the least, played a key role in absorbing T-bill issuance. The read-through is less reserve drain and thereby a longer runway for Fed QT.
If you ask Goldman, reserve drain will continue to be limited, or at least “contained,” as the bank’s Praveen Korapaty put it. RRP balances will likely decline by another $400 billion through year-end, he said, in his latest weekly.
Based on supply estimates, that $400 billion would fund an even larger share of issuance than RRP transformation has presumably accounted for so far, but Korapaty suggested it’s not that straightforward. “The decline in RRP balances almost exactly matches the shrinkage in the Fed’s balance sheet and the rebuild of Treasury’s cash balances” since the debt limit was suspended, he wrote. “Assuming Treasury tops off its account by raising an additional $200 billion and an ~$80 billion monthly decline in the Fed’s balance sheet, we calculate the upper limit of RRP losses from now to year-end will be around $520 billion, twice the estimate based on bill issuance.”
Those estimates remain highly uncertain and subject to any number of caveats, the simplest of which is just that RRP drain could stall and reserve drain could accelerate — so, a shift to a less benign trade off that what we’ve seen so far. Below, find some additional color from Korapaty, who elaborated on possible explanations for the ongoing decline in RRP against steady reserve balances.
What explains the significant erosion of RRP balances as opposed to reserves? One reason is increased money fund allocations to both bills and “other” repo. We had expected this RRP-heavy liquidity drain to moderate for two reasons: First, there are ongoing inflows into money funds (~$50 billion/month), and second, Treasury’s increased reliance on net coupon issuance, which would lean more on non-MMF demand. Yet moderation in RRP erosion has not occurred so far. One reason for this is the behavior of commercial banks. Smaller banks appear to be actively competing for deposits — indeed, most of the deposit loss appears to be occurring at larger banks. Banks of all sizes also appear to be encouraging a switch to large time deposits by offering higher yields, offsetting a major part of the decline in funds raised via other borrowing (e.g., FHLB advances taken out during March). In aggregate, banks have also continued to shed securities. On net, the combined effect of these actions has been sufficient to prevent any reserve losses thus far. Starting this month however, the pickup in net coupon issuance will be more noticeable, and we could start to see more reserve erosion. Nonetheless, current patterns suggest reserve losses might remain small through this year, and the RRP facility balances will likely decline another $400 billion or so by year-end, to about $1.15 trillion under our revised baseline.
