Key Highlights

• T-bill supply is running negative, and MMFs are increasing repo allocations
• Repo is generally cash-rich, but the Fed is on alert for strains
• Post-debt ceiling rebuild of TGA could reveal less-than-sufficient reserves in the system

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EXHIBIT #1: MMFS REALLOCATING TO REPO AND AWAY FROM BILLS

_{Source: BNY Markets, Crane Data}

Falling T-bill supply has left money market mutual funds (MMFs) flush with cash (ICI reports just under $7tn in AUM for the industry as of May 21). The amount of bills outstanding has fallen by some $127bn since the end of December as the debt ceiling bound at the end of last year, constraining Treasury’s ability to issue additional paper. With the squeeze in bill supply since the beginning of the year, MMFs with all that cash are increasingly turning to repo to allocate its large cash pile.

Since the beginning of the year through the end of April, MMFs have reduced their asset allocation to bills by even more than the decline in T-bill supply, some $278bn. As a “slice of the pie,” MMFs’ exposure to bills has fallen from nearly 41% at the end of 2024 to just under 38% at the end of April this year. At the same time, repo allocations increased by around the same amount ($231bn) as ownership of bills declined. The repo allocation has gone from 36% in December to almost 39% in April. Exhibit #1 depicts these changes.

One of the results of this supply-induced re-allocation is to temper the decline in MMFs’ usage of the Fed’s reverse repurchase program (RRP). Since the beginning of the year, daily RRP balances have averaged around $150bn, while since the beginning of April, it has been running at around a $163bn daily average. See Exhibit #2.

EXHIBIT #2: RRP HAS PLATEAUED THIS YEAR

_{Source: BNY Markets, Federal Reserve Board of Governors}

In a recent piece (see here), we illustrated that real money investors, as captured by iFlow, display inelastic demand for short-dated U.S. paper under 1y in maturity (i.e., mainly T-bills). The dynamics of T-bill issuance match up well with demand. With issuance currently negative, holdings by real money have fallen, and in the past, we have seen that when issuance ramps up, so too does buying. This relationship is almost the same when it comes to MMFs’ demand for bills. If bill supply drops, as it has recently, funds will move to other alternatives, and repo is one of them.

The debt ceiling also plays with front-end market dynamics beyond the impact of reduced T-bill issuance. We have pointed out many times that as the Treasury General Account (TGA) falls due to the debt ceiling, reserves increase, keeping liquidity flush. Of course, the Fed has been concerned with this mechanistic process, specifically the fact that this TGA-reserves dynamic could be quickly reversed once the TGA gets refilled post-debt ceiling resolution. This would drain reserves and could, in quick order, expose the system as having less liquidity than it previously appeared to have while the TGA was falling. This is the main reason why at its March meeting, the FOMC decided to slow the pace of QT.

This eventuality might mitigate the sanguine view of money market liquidity we have advanced, because here, too, the lack of bills has created excess liquidity that would not likely have been present if T-bill supply were on its normal path. The Fed has started to prepare us for a world in which funding market liquidity could fall as a result of these two processes.

In a recent speech, Roberto Perli, the manager of the Fed’s balance sheet (otherwise known as the SOMA – system open market account), intimated that there may be some strains starting to bubble up. What we think is the key paragraph of his speech is included here, emphasis ours:

“As the size of the Fed balance sheet continues to decline, however, and as reserves transition from abundant to ample levels, upward pressure on money market rates is likely to increase. We are starting to see the early signs of this in the repo market, especially around key reporting dates… This represents a normalization of liquidity conditions and is not a cause for concern; however, it does imply that, in the future, the SRF is likely to be more important for rate control than it has been in the recent past.”

In particular, around month- and quarter-end dates, RRP take-up increases, and repo rates tend to rise. Exhibit #3 shows this phenomenon and further illustrates that this wasn’t the case just a few years ago. Nevertheless, as Perli assures us, this is not cause for concern, but could indicate less flush liquidity conditions around periods of high demand for liquidity. 

EXHIBIT #3: ELEVATED REPO SPREADS AT MONTH-END MORE PROMINENT

_{Source: BNY Markets, Bloomberg}

It suggests that the Standing Repo Facility, where counterparties can go to the Fed to meet liquidity needs that are in excess of what is economically offered in the market, will increase in importance. The SRF was set up when QT was introduced back in June 2022 to provide this liquidity backstop in case conditions tightened, although it has been tapped sparingly by market participants so far. Certain administrative and other tweaks have been proposed, such as offering SRF operations during mornings – when funding needs are most prevalent (it is currently an afternoon-only operation), or allowing balance sheet netting, for example.

We have been relatively free of significant or persistent money market strains since QT began and the Fed’s balance sheet started to shrink. The Fed, however, is thinking a few steps ahead and laying the groundwork for the transition from abundant to ample reserves. The debt ceiling remains pertinent and will continue to affect front-end markets until it’s resolved, after which some changes sin market structure might be on offer.

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