Key Highlights

• Money funds are using repo and reverse repo less and buying more T-bills as supply increases
• Funding markets remain well-functioning, but we caution that they could tighten in September
• Powell’s Jackson Hole speech might stop short of endorsing a September cut

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As repo allocations fall, MMF T-bill purchases rise – whither funding markets?

EXHIBIT #1: RRP LOWER WHILE TGA RISES

_{Source: BNY Markets, Federal Reserve Board of Governors, U.S. Treasury}

On Monday, the Federal Reserve’s overnight reverse repo facility received just $38.2bn in its afternoon operation. While that sum is not quite as low as last Thursday’s $28.8bn, it represents the tenth consecutive day in which balances were below $100bn. So far in August, we have witnessed only one day during which RRP take-up was below that threshold. The last few days have been the lowest volume events since 2021, deep in depths of COVID, when counterparties were just ramping up their usage of the facility on the way to eventually topping out well above $2tn in late 2022 and early 2023. Given current trends, it’s not out of the question that we’ll see RRP usage to dwindle to negligible levels, or even zero.

This trend is effectively the other side of the rebuild of the Treasury General Account, itself initiated by the signing of the Republican budget bill in early July, allowing the resumption – and indeed, an acceleration of – T-bill supply. Exhibit #1, especially the 15-day moving average trend lines (dotted segments), helps us visualize the inverse relationship between the TGA and RRP.

Last week, we wrote that the combination of T-bill issuance and the related TGA rebuild would pressure funding markets, placing upward pressure on money market rates. But we haven’t yet started to see this in action. We suspect that’s because so far most of the increase in T-bill supply has been frictionlessly absorbed by money market mutual funds (MMFs). 

EXHIBIT #2: MMF ALLOCATION STARTING TO REVERT TO PRE-DEBT CEILING PATTERNS

_{Source: BNY Markets, Crain Data}

In Exhibit #2, we plot the evolution of asset allocation by MMFs (Crane Data’s Money Fund Index) over the past 12 months. In November 2024, the average allocations were heavily in favor of Treasurys (44%) as opposed to repo usage (34%). By the end of June this year, right before the budget bill was signed, this allocation preference had been reversed, with MMF assets allocated 42% to repo and just 34% to Treasurys, thanks to a lack of supply of the latter as the debt ceiling bit. Now, with new supply, we’re starting to see that reversed, meaning that cash in MMFs (whose total assets, according to Crane Data are currently over $7.5tn) is heading into T-bills at the expense of repo allocations. July’s allocations saw increased T-bill holdings (37%) and reduced repo allocations (40%). We fully expect these two lines to cross soon, with the MMF community primarily holding bills.

Whether or not this reallocation will be sufficient to absorb the still-to-come issuance of T-bills is unclear. At what point is demand for cash in repos going to raise rates, with MMFs primarily lending to the government via bills purchases rather than lending to counterparties in repo markets? We don’t have a point prediction, but we suspect that September will start to witness some tightness in funding markets, especially if we expect reserves to decline around the middle of the month with quarterly tax payments due on the 15th.

Jackson Hole might not offer clarity

This Friday will feature Fed Chair Powell’s annual breakfast address at the Kansas City Fed’s yearly central banker confab in Jackson Hole, Wyoming. The Fed Chair’s remarks are always widely anticipated by the market, as they are often seen as offering clues to future monetary policy. With the September FOMC meeting (on the 18th of the month) crucial, this is more so the case than usual. Will Powell offer confirmation to the market, which currently sees an 82% chance of a rate cut, or will he still play it coy, offering little guidance?

With political rhetoric high and personnel changes afoot on the FOMC (current Council of Economic Advisors Chair Stephen Miran has been nominated to replace outgoing Governor Kugler until her original term ends in January), the Fed is also confronting potentially the worst combination of weakening growth and deteriorating labor markets at the same time inflation has started to reaccelerate. We won’t get into the inflation and growth outlook here in detail, other than to say we expect the job market to deteriorate further and inflation to continue reaccelerating.

Our concern on inflation centers on the fact even without significant goods price increases (i.e., tariff effects have not yet been realized in the data), core inflation has risen for two straight months, primarily on the back of services. We estimate the current effective average tariff to be just 10% at the end of July, but expect that it will rise to well above 15% and maybe even closer to 20% when all is said and done. We still expect tariff effects to show up in goods markets in the coming months. This means that on top of rising services inflation, we’ll likely see goods inflation as well, with core CPI above 3% for most of the autumn into year end. Furthermore, we remind readers that the last Summary of Economic Projections from the FOMC in June saw year-end PCE inflation at 3.1% and unemployment at 4.5%. In other words, a stagflationary environment, something we believe we’re beginning to see the first signs of currently.

EXHIBIT #3: PRICING FOR SUCCESSIVE CUTS

_{Source: BNY Markets, Bloomberg}

Forward Look

If the market is to be believed (see Exhibit #3), the Fed will be cutting rates – presumably in response to weaker growth and employment – even if, as we believe, inflation is slowly but steadily picking up. Again, under this hypothesis, even with rising inflation, the Fed would be placing a higher weight on its employment goal than its inflation goal. This suggests that the Fed – per Governor Waller – would in practice be betting that inflation is going to come back on its own as tariff effects fade. It would be a risky bet, but one that we think would send the back end of the curve higher as the monetary authority’s inflation credibility comes into some doubt.

What then of the speech in Wyoming? We aren’t convinced that Powell will signal a cut around the corner, at least not in as many words. Rather, we presume that he will nod toward a potentially darker growth and jobs outlook, suggesting a cut could be in the offing, but cautioning on inflation and inflation expectations. He may also defend central bank independence and comment on the Fed’s ongoing policy review. If Powell speaks positively about a rate cut in September, even if only as a conditional possibility, we would expect the market to seize on this and firm up its bet on easier policy. We think this could be a mistake if it turns out that the August price data continue to show inflationary pressures in services and/or hint at them in goods prices.

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