Deep in the financial system plumbing, risks are rising. And the question is – will something break, as rates are hiked, and liquidity withdrawn? Massive Federal Reserve buying of Treasuries stabilized the market over the past two years, but liquidity gauges have eroded since the purchases stopped.
The market for U.S. Treasuries has grown to more than $24 trillion, expanding nearly tenfold over the past 20 years at the same time that major regulatory changes have blunted the ability of some bank-owned dealers of government debt to increase their purchases.
The Fed is this month accelerating the pace of winding down the nearly $US9 trillion balance sheet it built up for more than a decade in an effort to cushion the economy from shocks. It aims to shrink the total by $US95 billion a month — double the August pace.
Yet in fact the Federal Reserve Weekly Assets went up last week, which is weird, given the fact that Quantitative Tightening is meant to have started and we did see a fall in total assets less eliminations over recent weeks. But on the 14th of September the balance was reported at $8,832,759M, whereas the preceding week it was $8,822,401m, so a net rise of $10.36 billion.
Looking down the list of assets, we see US Treasury Securities fell by 3.73 billion, the bulk of which was bills, while mortgage-backed securities rose by $9.23 billion.
On the other hand, reverse repos rose by $66.8 billion (this is money parked at the Central Banks by Financial Institutions).
Right now, when bonds held by the Fed mature, the central bank churns the money back into the market. When it stops doing that, investment banks — known as dealers — must mop up any excess paper in the system on top of any new bonds that the US Treasury issues. It is not certain that the commercial sector has the stomach for this. Bank of America head of US rates strategy Mark Cabana said: “Dealers will inevitably be holding more Treasury inventory.
They’re going to have to finance that, which puts upward pressure on repo rates, that over time will probably contribute to more volatile Treasury markets, potentially worsening Treasury liquidity.” This is all looking a bit messy and a signal there are liquidity pressures emerging. In fact, the US Federal Reserve’s more rapid exit from crisis-era policies is placing the $US24 trillion US government bond market under extra strain, heightening concerns about the bedrock of the global financial system.
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