Plumbing Notes: The QT Enigma

enough funding alarm bells have chimed, with the Fed set to announce or initiate its next plumbing put. the enigma, however, is deciding when to unleash its next "bazooka" — sometime before year-end

Money Market Commentary

• What a difference a one or two weeks makes to sentiment. The majority of The Street is now calling for various interventions as if another repo crisis were only weeks or days away. But is ending QT (i.e. the Fed’s balance sheet reduction a.k.a “taper” a.k.a “runoff”) at the October FOMC a little too hasty? Conks estimates that the Fed’s “alarm system” is flashing amber but approaching red. It’s time to pull the plug. The question is when. SOFR is trading above IORB, yet interbank rates (EFFR) remain relatively subdued. Funding tensions, however, are rising enough for the Fed to consider ending a short but sweet “excess collateral” regime and initiating the next “excess cash” era, kicked off by ending its balance sheet reduction (i.e runoff).

• But beforehand, the Fed must conclude an epic years-long liquidity drain without fireworks, and both the Fed and dollar market makers face their biggest challenge yet. As mentioned earlier, the overlap between the Fed and Treasury’s goals will misalign at October month-end. The Treasury needs funding and will continue to drain reserves via the TGA (the U.S. government’s bank account). Meanwhile, the Fed desires abundant interbank liquidity, which depends on fewer reserves being “neutralized” in the TGA. With market makers pulling back as excess reserves reach their lowest level, October month-end will likely be the peak in funding pressure. November will experience less stress, given that the TGA will by then shrink and cash, i.e., bank reserves, will flow back into banks.