Forget The Fed And Jackson Hole: Treasury Is About To Unleash $500 Billion Quantitative Tightening
Three weeks ago, moments after the Treasury released its latest Treasury issuance Sources and Uses report which virtually nobody on Wall Street pays attention to, we confirmed something we first observed months earlier: stealth QE – which as we explained early this year is how the Treasury injected $1.5 trillion of liquidity into the market in the past 12 months bypassing the Fed entirely – was not only over but was about to go into reverse as the US Treasury was set to unleash several hundred billion of quantitative tightening.
The reason: after dropping to a post-covid low of $450 billion, the Treasury’s cash balance would first drop to $300 billion, and then continue declining for the duration of the debt ceiling negotiations (which will conclude successfully at some point in the next 2 months despite days of theatrical posturing as the US will not default) before surging to $800 billion by year end.
To be sure, the specifics of the upcoming Quantitative Tightening are still in flux and depend on when the US debt ceiling (which as a reminder was hit on July 31) and will be raised or extended: for all intents and purposes this is expected to take place some time “in October or November” which is when the debt limit deadline hits according to the CBO (that’s when the various emergency measures to extend the debt ceiling expire).
But while some last minute fireworks are assured, absent a compete collapse in the political process we expect another can-kicking extension in the debt ceiling some time in October or early November. To be sure, that means that the Treasury’s benign Sept 30 forecast of $750BN will not be met and instead Treasury cash levels will continue to shrink from current levels until there is some resolution.
Which brings us to another question: what are current cash levels at the Treasury? Well, after rising as high as $1.8 trillion last July, the cash held at the Treasury General Account has plunged to just $309 billion, the lowest level since the covid pandemic. This is largely due to the borrowing cap which has prompted the government to cut bill issuance and draw down its cash pile, while also putting tremendous downward pressure on short-term rates, pushing repo rates into negative territory, and breaching the Fed’s reverse repo 0.05% “floor” level as both Bills and overnight GC repo now trade below this level as discussed yesterday.
This means also that in the past 14 months, the Treasury – completely independent of the Fed – has injected a massive $1.5 trillion in liquidity into the market while soaking up massive amount of collateral, and is one of the reasons why today’s reverse repo print will be a record $1.2 trillion (on its way to $2 trillion or more by year end).
But now comes the reversal, and with Treasury cash dropping to its pre-covid levels the next move is higher, and sharply so once the debt ceiling is resolved.
Why do we bring this up? Because while most ignore this analyses when we posted it first in May and then again in early August, the financial experts are starting to wake up to the fact that the Treasury’s Quantitative Tightening is going to be a far greater factor for market liquidity in the near term than what happens at Jackson Hole.
First, an aside on Friday’s main event: as we have discussed ad nauseam, at 10am on Friday Powell may unveil that the Fed will begin tapering in September… or he may not. As Goldman noted yesterday, “there is a 45% chance that the formal announcement will come in November, a 35% chance that it will come in December, and 20%chance that it will be delayed until 2022.” The bank also said it expects the Fed to “taper at a pace of $15bn per meeting, split between $10bn in UST and $5bn in MBS.”
Bottom line: whether Powell reveals the taper or he doesn’t, the reality is that QE will still be with us for a long, long time even if the Fed starts shrinking its purchases in Q1 of next year, as the next Goldman chart shows.
But while the Fed’s tapering just means QE will still persist until mid- to late-2022, it is the Treasury’s QT that will be a far greater swing factor for market liquidity, especially once the debt ceiling is resolved and the Treasury starts draining liquidity at a furious pace by issuing debt – primarily in the form of Bills.
Why do we bring all of this up?
Because after ignoring the Treasury’s upcoming stealth QT, for months, Wall Street has finally woken up to the real threat to risk assets and as Bloomberg writes this morning, “Man Group last week wrote that because this implies the Treasury will be issuing more than spending, it’s effectively a form of quantitative tightening” just as we said in early August.
This, according to Man Group “could prompt investors to start cutting their rates positions eventually, though there’s usually a six-week lag between changes in the Treasury cash pile and the impact on longer-dated bond yields.” And since stocks, especially high duration tech names trade as a treasury proxy, once the selling in rates begins, it will quickly spillover to the FAAMGs which just happen to be the handful of generals propping up the entire market.
Below we republish the Man note, which while covering a topic we have discussed extensively, is something to keep an eye on as we believe many more traders will soon realize that Jackson Hole – and the taper in general – is just a distraction from the far greater QT coming up at the hands of the US Treasury which is about to unleash a massive Quantitative Tightening in the coming months, draining a whopping $500 billion in liquidity by year-end – assuming there is no further drain in Treasury cash which however is unlikely – and potentially as much as $800 billion should the Treasury cash drop to approximately $0 by November as the debt ceiling negotiations extend until the last possible moment, at which point the Treasury scrambles to refill its cash balance with a flood of Bill issuance
From Man Group
Do Treasury Cash Levels Imply Quantitative Tightening?
At the time of writing, it’s all but certain that Congress is unlikely to raise the US debt ceiling before the Senate leaves for summer recess. The debt ceiling is the maximum amount the US government can borrow to meet its financial obligations. When the ceiling is reached, the Treasury cannot issue any more bills, bonds, or notes. It can only pay bills through tax revenues, or by dipping into its savings (i.e., the cash balance) at the Treasury.
At the end of July, the Treasury’s cash balance was only USD442 billion, a relatively low level. For context, between the end of June and end of July, the cash balance fell by USD398 billion [ZH: it has since dropped to $309 billion]
In a ‘normal’ world (where the debt ceiling isn’t an issue), the US Treasury would not have tapped into its cash balance. Instead, it would have issued enough debt to match its spending needs. Net net, this would have no impact on markets – the amount the Treasury spends (which is like a cash injection into the US economy) would be offset by the amount of debt issuance (this would take liquidity out of the system as investors would be using their cash to buy US Treasury instruments).
However, in the last few months, the US Treasury has slowed down issuance because of the debt ceiling. This, in turn, has forced the Treasury to tap into their ‘rainy day’ fund and deplete its cash balance. Because it hasn’t done much issuance to take out liquidity, net net, these actions by the US Treasury have acted like substantial quantitative easing (i.e., cash injection without the offsetting liquidity withdrawal from issuance).
Separately, the Treasury has indicated that once the debt ceiling is increased, it plans to run the cash balance at USD750 billion. This would imply that the Treasury is taking more out of the system via issuance than it is putting back into the system via spending, because it is replenishing its rainy-day fund. This acts like quantitative tightening.
In addition, there is a roughly 6-week lag between changes in the Treasury cash account and the impact on longer-dated Treasury yields (Figure 1). As such, it is possible that Treasury yields may fall further or remain at the current low levels for another six weeks or so.
If private sector market participants still have any ability to anticipate future developments, then we are likely near the point where investors begin to reduce their rates positions to make room for the increased issuance that would take place the moment the debt ceiling rollover happens. In due time, this should have an impact on asset prices that depend on long-term yields.
Tue, 08/24/2021 – 11:32