With usage on the Fed's reverse repo hitting daily records as US Treasury supply shrinks as a result of a big drop in Bill sales, supply-demand imbalances continue to weigh on the U.S. dollar funding space as money-market rates, from Treasury bills to repurchase agreements, trade below the new yield on the Federal Reserve’s reverse repo facility.
As shown in the chart below, most Treasury bills through the 1Y tenor are yielding less than 0.05%, the yield on the Fed's Reverse Repo facility.
Also overnight GC repo opened at 0.04% before dipping to 0.03%, according to Oxford Economics
Just in case it wasn't obvious from the above charts, on Friday JPMorgan strategists Teresa Ho and Alex Roever wrote that "with the supply and demand gap now having grown to $1.35 trillion, it’s not surprising that the Fed’s ON RRP is providing only a soft floor for money-market rates.”
What is troubling is that even with the Fed’s taper, the distortion isn’t going to change any time soon, the strategists wrote echoing what we discussed previously namely that even if the Fed completes its asset purchases by August 2022, that still means there could be anywhere from $850b to $1t of additional liquidity injected into the financial system, further exacerbating the imbalance. A slower taper could mean as much as $1.5 trillion in new liquidity.
Adding to the confusion, Bloomberg notes that the timing of a debt-ceiling resolution remains “highly uncertain,” which suggests further declines in net Treasury-bill issuance.
“More QE and less T-bills mean higher RRP balances,” JPM wrote, adding that this is "something we have already seen as RRP usage has now surpassed $1.1t."
Finally, the latest money market distortion was flagged by Curvature's Scott Skyrm, who on Friday noted that last week overnight agency MBS collateral began trading below US Treasury collateral in the Repo market. While technically they're all obligations of the US government, Skyrm said that "since agencies are slightly less liquid and are GSEs instead of direct obligations, agency MBS will trade between 1 and 3 basis points above Treasurys overnight and between 4 and 7 basis points term - depending on the tenure." But as he noted, the overnight relationship flipped recently. Skyrm was unable to answer why.
He also laid out the next question which is why would an investor take Fannie, Freddie, or Ginnie paper at a lower rate than Treasurys? One possible answer is that some cash investors are required to invest a certain amount of their cash in agencies - probably as an attempt to diversify. Under normal market conditions, that helps generate a couple of extra basis points, "but when the Fed's buying $40 billion of agency MBS paper a month, there's a lot less supply in the market", according to Skyrm. As the Curvature strategist concludes, "Bottom line - there's less agency MBS paper around in the Repo market and that's distorting rates" to which we can add that there is a shortage of every type of paper in the repo market and the Fed's reverse repo floor has now been completely breached as a result.