Key Highlights

• Treasury has announced reductions in T-bill supply
• Money funds have to look elsewhere to place cash – affecting RRP and reserves
• Powell testimony and inflation data underscore monetary policy uncertainty

Declining bill supply to affect Fed liabilities

EXHIBIT #1: MMFS SHOW INELASTIC DEMAND FOR BILLS

^{Source: BNY Markets, US Treasury Department, Crane Data, Bloomberg}

Our take

The US Treasury has started to cut T-bill issuance. This was expected, given that the debt limit has been reached and extraordinary fiscal measures have been adopted, and tax season is approaching. The next step in the debt ceiling playbook is to reduce bill supply. We think this could induce a rebound in the daily uptake in the Fed’s reverse repurchase facility (RRP), which has been recently dwindled to an almost negligible amount, consistently less than $100bn, below mid-2021 levels. 
 
In Exhibit #1 we show cumulative net T-bill supply and plot that against money funds’ Treasury holdings. The relationship over time is clear. Money market mutual funds (MMFs) appear to have almost inelastic demand for bills and are happy to increase holdings of them as supply increases. This includes the initial years of the pandemic when issuance ramped up to fund Covid-related support payments. 
 
Notice, the period highlighted by the orange circle. Money funds reduced their Treasury holdings starting in 2021 with a decline in bill issuance after the initial ramp up in supply associated with Covid-related spending. By 2023, the debt ceiling episode of that year dissuaded heavy bill issuance, and MMFs were avoiding bills due to both their scarcity following supply cuts, and to avoid holding securities that were potential default categories. After the debt ceiling was postponed in mid-2023, both bill supply from Treasury and bill holdings among money funds increased. 
 
iFlow shows that this behavior is not at all dissimilar from the behavior of institutional real money investors outside of the money fund complex. Exhibit #2 shows a rolling 20d measure of net T-bill supply against a rolling 20d average of flows into short duration (0-1y in maturity) sovereigns, mainly bills. T-bill issuance is snatched up by these investors almost completely inelastically. 

Forward look

With the upcoming reduction in bill supply, we think MMFs, which now hold over $7trn in assets, will have to put cash elsewhere, and we think RRP will benefit, mitigating the pressure for reserves to rise with what we expect will be a looming drawdown in the Treasury General Account, which will also be a feature of the debt ceiling process. 

Powell makes indefinite hold official 

EXHIBIT #2: REAL MONEY DEMAND ALSO INELASTIC 

^{Source: BNY Markets, iFlow, Treasury Department}

Our take

In his Congressional testimony last week, Fed Chair Powell essentially declared an indefinite hold on rates. Since the election last November, markets have priced out nearly one full rate cut this year and are now expecting just slightly more than one full cut (of 25bp) by December. 
 
We have previously discussed how policy uncertainty across trade, immigration, regulations, and fiscal policy have led to significant monetary policy uncertainty and a general wait-and-see approach among investors. Certainly, the near daily tariff discussions have generated the bulk of the short-term uncertainty, but Federal Reserve officials have – correctly, in our opinion – pointed to uncertainty across a raft of policy areas, making it difficult to assess the economic outlook, as well as the related monetary policy implications.  
 
Stronger than expected CPI and PPI data last week have increased the perception that the Fed will be on hold for the majority of the year, and that’s even considering potential price spikes that would likely occur if tariffs were indeed implemented. The Fed could be looking at inflation from two sources – sticky (or even reaccelerating) inflation due to the economy and labor market still running hot, as well as tariff-generated price increases. Does the central bank tighten policy at the potential cost of weakening demand while the economy could be in a vulnerable place due to a trade war? 
 
We think it’s too early to say at this point. There is evidence that January’s strong CPI and PPI readings suffer from so-called residual seasonality. That is, even after the Bureau of Labor Statistics performs its regular seasonal adjustment, there are still unaccounted seasonal effects in price data in the first few months of the year. Furthermore, economists can get a good read on the upcoming PCE print with information obtained through the CPI and PPI data. Despite beating expectations, the data point to a well-behaved PCE print later this month.

Forward look

There is a lot of noise around the monetary policy outlook, with multiple competing factors at play and high policy uncertainty. We had been expecting two cuts this year, but the current scenario and data developments cloud our own outlook as well. We now think one cut – much later in the year – is more likely than two, and even that one cut might not happen.

EXHIBIT #3: MARKET EXPECTATIONS HAVE PRICED OUT ALMOST A FULL CUT SINCE THE ELECTION 

^{Source: BNY Markets, Bloomberg}