USD Weakness: Liquidity Strain March Q1, Treasuries, Quantitative Easing, Market Plumbing

The March strain.

Spoke to a learned friend who gave me an interesting tip, and suggested I do a deeper look into the mechanics unfolding end of Q1. Here is the break down, some of which was part of our chat.

T-Bill auctions + S & C Corp tax deadlines + Near-empty RRP

The March-April corporate tax cliff is nearing. Large sums of money have to be reconciled and shuffled off out of the private sector and into the Fed TGA (Treasury General Account).

This depletion of funds from the ledgers of private banking institutions increases pressure on the liquid funds available elsewhere.

The Reverse Repurchase Agreement (RRP) as the Liquidity Reserve

Under normal circumstances Money Market Funds (MMFs) have trillions parked in the RRP as a safe haven and return. These funds are liquid and consistently made available by MMFs to Market Makers for arbitraging purposes, and market liquidity.

So what's the problem?

The T-Bill Siphon

With escalating U.S. gov deficit the Treasury has mass sold T-bills, incentivising the purchase of the rampant bills by applying slightly higher yield than the Fed's RRP rate.

Now an MMF can see the unrealised loss of holding funds in the RRP compared to bonds & bills, resulting in movement of money out of the RRP…

The Market Maker Gets Choked Out

As the RRP empties, Market Makers will struggle to find cheap cash to arbitrage the difference between Treasury yields and Repo rates and provide market liquidity. This tends to leave private sector baking (& effectively themselves) as the go-to for liquidity sourcing, right at the same time banks also want to hold more cash on their balance sheets.

And as foreign Treasury buyers thin out (China, Japan, etc) these same Market Makers are forced into buying unwanted Treasuries.

Voila. No cash, all Bonds.

Current status?

The RRP balance is down from 2.5T to ~$3B

So:

1. The RRP is empty.
2. The Banks are hoarding.
3. The Market Makers are full on bonds with low cash positions

This can lead to a suboptimal Treasuries Auction where yields spike. A significant yield spike is not good.

Gov Management Strategies?

To navigate this crunch without the RRP buffer, the government and the Fed have four primary levers.

1. QE via The Standing Repo Facility/SRF

Fed prints cash, buys back unwanted Treasuries for cash, lower yields and saves the market & day. Massively inflationary.

2. Treasury Buybacks

The U.S. Treasury recently launched a formal buyback program

TGA account funds are used to buy back old and unwanted bonds, and then new bonds are issued. This lower yields and also gives Market Makers the liquidity to buy future bonds and stabilise Treasury auctions.

3. Regulatory Relief

Right now banks are capped on the amount of bonds vs cash they can hold on the books due to leverage ratio regulation. They are at their maximum bond-holding capacity relative to cash positions. If the regulation is eased or treasuries are exempt from the calculation, magically more bonds can be bought.

4. Long Haul Financial Repression

Forcing institutions to hold government debt at artificially low rates.

The buyback is already in place as evidenced in the past quarter. The SRF is likely to also be moved into motion in the short term as a crisis aversion method. And financial repression is almost inevitable over the longer term

All these liquidity intervention strategies are inflationary and point to a structurally weaker USD over time.

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