Jokers high

Unless the Fed's RRP falls substantially soon, more market players may fold.

The current rate of the Fed’s Quantitative Tightening ($95 bln per month, average) is accommodated on its liability side by three subcategories; bank reserves, Treasury General Account (TGA) or Reverse Repurchase facility (RRP). Perhaps we can think of them as the ace, the deuce and the ‘joker’ respectively in terms of market functioning. And just as in less consequential games, how the cards fall determines who loses.

Photo by Amanda Jones on Unsplash

Since QT reaching ‘full speed’ in late August 2022, the RRP has declined average $13bln per month, bank reserves have fallen an average of $40 bln per month and TGA has fallen an average of $38 bln per month, or a total of $92bln per month on average - pretty much in line with the Fed’s planned $95bln per month. The ‘deuce’ TGA has worked really hard despite its lowly status.

Some challenging questions may shortly arise. As the numbers above confirm, to date the TGA absorbed as much liquidity reduction as bank reserves. But that cannot go on for much longer. TGA balances at $434bln are approaching the median level of TGA balances held between 2016 and March 2020 of $300bln. As COVID hit, TGA balances exploded, but that was a special case. Instead, focus on the historical median level of $300bln as a guide for future balances. At current depletion rates, that level will be hit in 3 ½ months - around April.

In fact, it would reasonable to expect TGA balances may rise somewhat in coming months. Partly as a precaution by the Biden administration whose expenditures continue to soar. And partly because April tax returns will be filed and tax rebates will begin shortly afterwards, requiring further cash on hand to pay tax-payers.

If TGA balances rise, the difference in financial liquidity has to come from RRP or bank reserves. So far, the RRP has shown stubborn refusal to decline, largely because banks do not wish to expand their dealings with money-market funds, a factor that is unlikely to change much. The RRP remains the ‘joker’.

If the RRP remains at current high levels, then all future liquidity adjustment will have to be met by bank reserves. There is no known lower bound for bank reserves though the Fed has agreed that it will continue to provide ‘ample’ liquidity. But it simply has no way of telling what ‘ample’ means, until market dysfunction reveals an absence of ‘ample’. This is not a recipe for asset price appreciation. Quite the reverse. Bank reserves may be the ace for financial liquidity, but if you don’t have any aces, you may have to rely on jokers (RRP) to avoid losing.