The Fed Drains $ 485 Billion in Market Liquidity Via Reverse Repurchases, Canceling 4 Months of QE Even as QE Continues, Total Assets of Nearly $ 8 Trillion
It’s a crazy situation the Fed has backed off as the liquidity tsunami goes haywire, the banking system weighs less than $ 4 trillion in reserves, and the general treasury account is used up.
By Wolf Richter for WOLF STREET.
This morning, the Fed sold a record $ 485 billion in Treasury securities via overnight “reverse repurchases” to 50 counterparties, breaking the previous record set on December 31, 2015. These overnight repurchases day will expire and unwind tomorrow morning. Today, yesterday’s $ 450 billion overnight repurchase agreements have matured and unwound, and have been more than replaced by this new batch of $ 485 billion overnight repurchase agreements. .
Reverse repurchase agreements are liabilities on the Fed’s balance sheet. They are the opposite of repos, which are assets. With these repurchases, the Fed is sale from Treasury securities to counterparties and take their cash, thus massively draining liquidity from the market – the opposite effect of QE.
In the past years of significant reserves following QE, banks divested themselves of reserves via reverse repurchase agreements, reducing reserves on the balance sheet and increasing their Treasury holdings, to dress their balance sheets at the end of the quarter, and particularly at the end of the year. Reverse repurchases fell after the Fed began to curtail its assets during quantitative tightening in 2018 and 2019. But the current record spike comes in the middle of the quarter, a sign that the massive amount of liquidity is going haywire:
It’s a crazy situation the Fed has backed down.
Even as liquidity goes haywire and the Fed tries to manage it through reverse repurchase agreements, the Fed still buys around $ 120 billion a month in treasury and mortgage-backed securities, adding liquidity.
But with its reverse repos of $ 485 billion, the Fed canceled four months of QE!
The Fed could stop buying securities altogether and shrink its balance sheet, which would also drain liquidity from the market. But the Fed can’t do that because it said it would be slow and deliberate in announcing changes in its monetary policy, and could possibly talk about talking about tapering, so it can’t suddenly turn around. -face.
But this situation of liquidity disruption appears to be an emergency that must be resolved. now, and therefore the Fed approaches it through the back door via reverse repurchase agreements overnight.
At the same time, the Fed is continuing its QE. Its total assets stood at $ 7.90 trillion on its balance sheet as of May 26, released today, were down $ 19 billion from last week’s record, following the usual trend. These assets include $ 5.09 trillion in treasury securities and $ 2.24 trillion in mortgage-backed securities (MBS):
The Fed discussed this liquidity issue at the last FOMC meeting and summarized some of the discussions in its minutes of meetings. He noted that “a modest amount of trading” in the reverse repo market had taken place at negative yields, meaning there is so much demand for Treasury securities, and so much liquidity in their hands. lawsuit, that the holders of cash were prepared to lose money to obtain Treasury securities. This threatens to push linked rates into the negative, such as the SOFR (Secured Overnight Financing Rate) which is the Fed’s benchmark rate to replace LIBOR.
The Fed, sitting on $ 5.09 trillion in Treasuries, has entered the reverse repo market, selling Treasuries overnight to meet this demand for Treasuries and prevent yields to meander below zero.
The liquidity tsunami.
Everyone has their own theory as to why there is so much demand for Treasury securities. But one thing we do know: The banking system is crunching under a huge amount of liquidity.
Bank reserves on deposit with the Fed – a liability on the Fed’s balance sheet, money the Fed owes banks and on which it currently pays banks 0.1% interest – have swelled to a record 3 , $ 98 trillion on April 14 and have since zigzagged down a strand. On the Fed’s balance sheet released today, they stood at $ 3.81 trillion. This is a sign of how much liquidity banks are swimming in:
The drawing of the general treasury account.
The government sold a gigantic amount of debt last spring, adding $ 3 trillion to its debt in a matter of months and kept the unspent amounts in its checking account – the General Treasury Account or GTA at the Fed, which is a liability for the Fed, money it owes the US Treasury. The GTA balance climbed to $ 1.8 trillion in July 2020, from the pre-crisis range of $ 100 billion to $ 400 billion.
Mnuchin’s Treasury started spending the current account balance by borrowing a little less. By early January, the GTA had fallen to $ 1.6 trillion.
Treasury Yellen formalized the withdrawal and announced in early February that it would reduce the balance to $ 500 billion by June. That turned out to be too too quick, and now it looks like August will be the month when the drawdown hits the $ 500 billion mark.
On the balance sheet released by the Fed today, the balance as of May 26 was down to $ 779 billion. Down $ 821 billion since February, $ 279 billion remains:
The withdrawal from the GTA has implications for the markets: it is money the government will spend but does not have to collect taxes or borrow; he already borrowed it from March to June of last year. And the Fed has paid off that debt with its $ 3 trillion in asset purchases. The drawdown therefore means that the government spent this money that the Fed had already monetized in the spring of last year.
All of this has big implications for the markets. These are huge amounts, in terms of reserves on deposit with the Fed, withdrawal from GTA to the Fed, and now reverse repos to the Fed, all liabilities to the Fed, all representing different aspects of the massive cash flow that now bounce off the walls.
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