Debt Ceiling Drama Will Keep Pressure On Stocks

Authored by Simon White, Bloomberg macro strategist,

Pressure on reserves and extra demand for the Fed’s RRP facility will keep weighing on stocks and other risk assets.

Debt-ceiling dynamics are distorting the Treasury bill curve. Bills are first in the line of fire if the debt ceiling becomes binding due to the way they are issued. This is leading to a surfeit of demand for bills which mature before “X Day”, the day when it is anticipated the Treasury will hit the debt ceiling. Tax payments are slower than average this year, bringing estimates for X Day to early June.

This has led to 1-month bills yielding only ~3.75% versus 3-month bills at ~5%. The current overnight RRP rate is 4.80%. We can use the rates implied by Fed Funds futures to imply what the 1-month and 3-month RRP rates would approximately be.

The chart below shows that the RRP is more attractive than 1-month bills by a long way, while roll-adjusted 3-month bills are slightly above the implied RRP rate, but the RRP does not face the same default risk. Six-month bills are also less attractive than the RRP.

This will likely divert more reserves to the RRP facility, already sat near its highs at just under $2.7 trillion. A rising RRP typically leads to falls in stock prices.

The RRP drains reserves from the system, i.e. velocity, and this tends to lead to weaker risk-asset prices. We can see that the “impulse” of reserves (the change of their change) is already falling. As the debt-ceiling drama heats up, this will put further pressure on reserves and thus risk assets in the shorter term.

The NY Fed yesterday announced some counterparty restrictions on the use of the RRP, limiting use for entities solely set up to use the facility, but this is unlikely to be enough to significantly alter the current short-term dynamics.