According to Barclays rates strategist Joseph Abate, record demand for the Federal Reserve’s overnight reverse repo program could reach a new high of $1.4 trillion by year’s end.
This is primarily because he expects demand for the facility to rise if debt-ceiling talks in Washington drag on into the fall, causing the already dwindling supply of Treasury bills to shrink even further.
Treasury Secretary Janet Yellen urged Congress on Wednesday to suspend or raise the debt ceiling, claiming that “cash and extraordinary measures will most likely be exhausted during the month of October.” The debt-ceiling talks are part of a long to-do list for US lawmakers in the coming weeks, which could jolt markets, writes MarketWatch’s Victor Reklaitis. Because the Fed’s reverse repo facility still has room to grow, some on Wall Street see the program as yet another tool for the central bank to use to help calm markets during difficult times.
Earlier this month, Abate referred to the Fed’s reverse repo program as a “replacement bill provider” to the US Treasury, describing it as a critical alternative for cash investors who would otherwise keep their liquidity in bills. Since April, demand for the facility has increased as low global rates and trillions of dollars in pandemic stimulus have washed through financial markets.
The overnight Fed program has been a safe haven for money-market funds and other financial firms looking to park the flood of cash that has been sloshing through the financial system overnight while retaining its value.
In June, use of the facility approached $1 trillion for the first time, after the central bank raised the rate it paid to users from zero to 5 basis points as part of its effort to keep short-term rates in the Fed’s target range of 0 percent to 0.25 percent. Now, the facility may be required to keep markets from crashing if Congress does not act to raise or suspend the debt limit before time runs out in the coming months.
What’s the main reason? The Treasury-bill market has shrunk by nearly $850 billion this year, and Abate expects it to shrink by another $300 billion as prolonged debt-ceiling talks force the Treasury to spend down its cash account and reduce bill issuance.
According to Abate, the Treasury had about $459 billion in cash at the Fed by the end of July, when the debt-ceiling suspension expired, and he expects the Treasury to have enough cash and borrowing capacity to operate normally through the end of October.
Stock investors have largely dismissed concerns about the debt-ceiling impasse, despite the Dow Jones Industrial Average, 500 index, and Nasdaq Composite Index being under slight pressure Wednesday on concerns about a potentially slower pace of economic recovery. The yield on the 10-year Treasury note was close to 1.34 percent.
However, if a debt-ceiling agreement is not reached soon, anxiety about potential bill repayment delays may grow this fall. According to Abate, this could cause more money to be pushed into the Fed’s overnight repo facility, pushing it past the $1.4 trillion mark. Until a deal is reached, the Fed facility could act as a stabilizing force. Specifically, the Fed raised the cap on how much each counterparty could park overnight in the reverse repo facility to $80 billion several months ago, but those limits haven’t been reached.
Abate estimated last month that money funds, a key component of the overnight program, were using only about 25% of available RRP capacity while also acting as a broader market stabilizer. “In addition to meeting money funds’ unmet bill demand, the RRP has helped to put a floor under all market rates,” Abate wrote, adding that 3-month Treasury bills have traded near the RRP rate since it was raised to 5 basis points.
Even if Washington is able to reach a debt-ceiling agreement by October, demand for the Fed’s overnight program will not cease abruptly, according to John Canavan, a lead analyst at Oxford Economics.