background image

Macro update: Contrary to Market Expectations, Data Shows Mitigated Liquidity Impact as US Treasury Refills General Account

Macro 7 minutes to read
Redmond-400x400
Redmond Wong

Chief China Strategist

Summary:  The latest data contradicts the anticipated liquidity drain as the US Treasury replenishes its General Account (TGA) at the Federal Reserve. Analysis reveals that money market funds' purchase of Treasury bills using reverse repo balances has mitigated the liquidity impact. The data shows that a reduction in overnight reverse repo balances counterbalanced the TGA increase. Moreover, bank reserves at the Federal Reserve were nearly unchanged, indicating no contractionary impact on banking system liquidity.


The background

Following the enactment of the debt-ceiling bill on June 3, the US Treasury has unveiled its plan to increase the cash balance in the Federal Reserve's Treasury General Account (TGA). While market participants have expressed concerns about the potential impact on liquidity within the banking system and derailing the equity market rally, we have been arguing that much of the potential liquidity drain might be mitigated by money market funds deploying their reverse repo balances at the Fed to buy Treasury bills. An analysis of the latest data validates our hypothesis and suggests that the prevailing fear may be overblown.

Examining the TGA increase and its impact

The magnitude of the perceived impact hinges on the source of the TGA increase. It is crucial to assess whether it arises from a reduction in bank excess reserves, depleting banking liquidity, or a decrease in the reverse repo balances of the money market fund at the Fed, which would transfer liabilities on the Fed's balance sheet without affecting banking liquidity.

When investors were to withdraw funds from their bank accounts to purchase the newly issued Treasury bills, subsequently leading to the Treasury depositing the resulting proceeds into the TGA, it will lead to a reduction in the banking system’s reserve balance at the Federal Reserve. For example, if the Treasury issues USD10 billion T-bills and investors buy the T-bills by using the money in their deposit account at commercial banks, it will cause a decline of USD10 billion in deposit (liabilities) and a fall of USD10 billion in reserve at the Federal Reserve (assets) of the US banking system’s balance sheet (Figure 1) and results in a USD10 billion decline in liquidity in the US banking system.

 

Figure 1
Figure 1: Scenario for liquidity drain; Source: Saxo

However, many of the investors who buy T-bills are money market funds. Money market funds typically invest in two major asset classes: T-bills and reverse repos with the Fed. These reverse repurchase agreements, or reverse repos, are overnight lending from the money market funds to the Fed and the Fed gives the money market Treasury securities as collateral and pays an interest currently at 5.05%.

Therefore, when money market funds buy Treasury bills in the auction from the Treasury by reducing their reverse repo lending to the Fed, the liquidity of the banking system would remain unaffected as the Treasury deposits the acquired funds into the TGA at the Fed. (Figure 2)

Figure 2
Figure 2: Scenario for unchanged liquidity in the banking system; Source: Saxo

TGA increase has not affected liquidity in the banking system

Examining the latest data from the Federal Reserve H.4.1 report offers valuable insights into the developments surrounding the Treasury General Account (TGA). The report indicates a significant increase of $243.6 billion in the TGA, rising from $48.5 billion on May 31, 2023, to $292.1 billion on June 21, 2023. However, it is essential to note that this increase was nearly offset by a $217.8 billion decrease in the overnight Reverse Repo balance at the Fed during the same period, dropping from $2,254.9 billion to $2,037.1 billion. This tends to support the hypothesis that money market funds have been reducing overnight reverse repos with the Fed and using the money to buy Treasury bills.

In this process, the increase in the TGA balance has not affected liquidity in the banking system. In fact, US banks' reserves in the Federal Reserve system were almost unchanged at $3,204 billion on June 21, from $3,205.5 billion on May 31, countering concerns over liquidity drain.

Figure 3 and Figure 4 below illustrate the changes in the TGA balances, overnight reverse repo balances, and reserves held by banks at the Fed.

Figure 3
Figure 3: TGA, overnight reverse repos, and bank reserves as of May 31, 2023; Source: Federal Reserve
Figure 4
Figure 4: TGA, overnight reverse repos, and bank reserves as of June 21, 2023 Source: Federal Reserve

Shifting investment preferences as the Fed makes a pause

Driven by the Federal Reserve's decision to postpone a rate hike in June and market expectations of only one more hike before the cycle concludes in July, money market funds have exhibited a preference to shift funds from overnight reverse repos to capitalize on the higher yields offered by Treasury bills. With the Fed currently paying an overnight interest rate of 5.05% to money market funds, the investment rates on Treasury bills, ranging from 5.113% to 5.511% in recent auctions, present an attractive alternative. This shift in investment preferences not only reduces exposure to reverse repos but also mitigates potential liquidity concerns.

The dissipation of liquidity risks supports the equity market

Upon reassessment, the initial fears surrounding the impact of the Treasury's cash balance strategy on banking system liquidity appear exaggerated. The latest data indicates a more balanced dynamic, with offsetting factors contributing to maintaining adequate liquidity levels. While vigilance remains crucial, particularly in monitoring the sources of TGA funding and their implications for market dynamics, it is reasonable to expect the absence of a feared liquidity crunch will contribute to supporting the equity market.

 

 

 

Quarterly Outlook

01 /

  • Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Quarterly Outlook

    Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges

    Althea Spinozzi

    Head of Fixed Income Strategy

  • Equity Outlook: Will lower rates lift all boats in equities?

    Quarterly Outlook

    Equity Outlook: Will lower rates lift all boats in equities?

    Peter Garnry

    Chief Investment Strategist

    After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto...
  • FX Outlook: USD in limbo amid political and policy jitters

    Quarterly Outlook

    FX Outlook: USD in limbo amid political and policy jitters

    Charu Chanana

    Chief Investment Strategist

    As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ...
  • Macro Outlook: The US rate cut cycle has begun

    Quarterly Outlook

    Macro Outlook: The US rate cut cycle has begun

    Peter Garnry

    Chief Investment Strategist

    The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c...
  • Commodity Outlook: Gold and silver continue to shine bright

    Quarterly Outlook

    Commodity Outlook: Gold and silver continue to shine bright

    Ole Hansen

    Head of Commodity Strategy

  • FX: Risk-on currencies to surge against havens

    Quarterly Outlook

    FX: Risk-on currencies to surge against havens

    Charu Chanana

    Chief Investment Strategist

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo...
  • Equities: Are we blowing bubbles again

    Quarterly Outlook

    Equities: Are we blowing bubbles again

    Peter Garnry

    Chief Investment Strategist

    Explore key trends and opportunities in European equities and electrification theme as market dynami...
  • Macro: Sandcastle economics

    Quarterly Outlook

    Macro: Sandcastle economics

    Peter Garnry

    Chief Investment Strategist

    Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p...
  • Bonds: What to do until inflation stabilises

    Quarterly Outlook

    Bonds: What to do until inflation stabilises

    Althea Spinozzi

    Head of Fixed Income Strategy

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ...
  • Commodities: Energy and grains in focus as metals pause

    Quarterly Outlook

    Commodities: Energy and grains in focus as metals pause

    Ole Hansen

    Head of Commodity Strategy

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)

Saxo Bank A/S (Headquarters)
Philip Heymans Alle 15
2900
Hellerup
Denmark

Contact Saxo

Select region

International
International

Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

This website can be accessed worldwide however the information on the website is related to Saxo Bank A/S and is not specific to any entity of Saxo Bank Group. All clients will directly engage with Saxo Bank A/S and all client agreements will be entered into with Saxo Bank A/S and thus governed by Danish Law.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.