Your Survival Guy sees the Treasury market losing its shock absorber as a path to higher interest rates. Not that I’m in the prediction business, but when liquidity tightens up, aren’t buyers going to demand higher interest on their money? Eric Wallerstein explains in The Wall Street Journal, writing:
Participation is dwindling in a Federal Reserve program that has helped the U.S. government limit its borrowing costs, a development that many investors say presages higher interest rates and larger swings in the $26 trillion Treasury market.
The overnight reverse repurchase facility, known on Wall Street as reverse repo, enables large financial firms such as money-market funds to briefly swap extra cash for high-quality securities on the central bank’s balance sheet and pocket some interest. The Fed program has been used heavily in recent years, at one point hitting $2.5 trillion of daily balances, but that number has shrunk steadily and recently fell below $500 billion.
Many analysts and portfolio managers expect use of the program to continue to decline, which they say is likely to constrain the functioning of an important shock absorber in the market for U.S. Treasury securities. The government is facing higher interest costs as it attempts to fund a growing deficit, and observers say lower balances in the program could mean higher volatility and a fresh rise in interest rates in the market that underpins the global financial system.
“It is undoubtedly easier for the market to absorb bill supply if you have a large amount of cash in an overnight facility waiting to be deployed,” said Michael de Pass, global head of rates trading at Citadel Securities.
Though obscure, reverse repo has long been at the center of the operation of the financial system and the U.S. economy. A committee that advises the Treasury suggested last fall that the heap of money-market fund cash sitting at the Fed could finance a flood of short-term bill issuance—an unusual shift that in recent months has enabled the government to keep long-term interest rates relatively low despite the quickening drumbeat of U.S. debt issuance.
Sales of Treasury bills, which mature in a year or less, surged during the pandemic and then again in 2023. There is now nearly $6 trillion of T-bills in the market, up from less than $2 trillion at the end of 2017.
That might seem like a technical development, but it is anything but for players in the global bond market. All this short-term debt will need to be refinanced at higher rates at the same time the Fed has been lifting benchmark interest rates. While selling bills allows the government to raise cash quickly, the bills soon come due, forcing difficult decisions on how to raise funds again.
Action Line: Tighter money conditions could have harmful effects on businesses and governments that have enjoyed refinancing at low rates for a long time. Be watchful and aware of what is happening. Click here to subscribe to my free monthly Survive & Thrive letter.
