The US Economy is FLOODED With Excess Cash: What Does This Mean For The Reverse Repo Market?

America’s debt ceiling is slated to return come the end of July, spelling potential ramifications for the Treasury, as well as the entire financial system which is bursting with excess liquidity.

With the debt ceiling coming into effect within a matter of weeks, the US Treasury faces a difficult task: it must lower its cash balance prior to the July 31 deadline, and thus inject even more money into the US economy— which is already drowning in a monsoon of cash. As a result, the Federal Reserve’s reverse repo facility (RRP) was flooded with an additional trillion dollars in cash this week.

The RRP was first created in 2013 as a means to absorb excess cash throughout the repo market, as well as to create a robust floor to support the Fed’s policy rate, which currently sits between a target range of 0% to 0.25%. Qualifying parties, such as certain hedge funds and major US banks, are able to lend the Fed cash in exchange for overnight Treasury collateral.

However, America’s banking system currently faces a plethora of additional cash, due to the Fed’s generous quantitative easing program, as well as the Treasury’s unlimited support of the government and subsequent US economy in response to the Covid-19 pandemic. As a result, the Treasury General Account (TGA) now has a cash balance of $711 billion as of June 29, according to data cited by Reuters, and it must reduce that balance to a target of $450 billion before July 31.

Last month, the Fed has adjusted the interest rate paid banks on excess reserves (IOER) from 0.1% to 0.15%, as well as raised the the reverse repo rate from 0% to 0.05%. The upward rate change has created the sudden surge in reverse repo volume— with more likely to come, particularly as a drawdown in the TGA will boost reserves in the banking system, which will subsequently flow into the RRP market.

So, should all of this be a cause for concern? Well, the RRP overnight rate hike could diminish the demand for US Treasury bills, because their interest rates would now be relatively lower, and their date to maturity a lot longer. However, as Credit Suisse global head of -short-term interest rate strategy Zoltan Pozsar points out, the shift into RRPs from T-bills will likely be gradual, given that bills are currently historically low, meaning they can only be disposed of at a loss. “But happen it will,” he cautioned.

Information for this briefing was found via Reuters and the companies mentioned. The author has no securities or affiliations related to this organization. Not a recommendation to buy or sell. Always do additional research and consult a professional before purchasing a security. The author holds no licenses.

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