As Treasury secretary Yellen takes over the helm of the U.S. government sailboat from Steve Mnuchin, there has been a question circling over the past few weeks about the issue of the massive Treasury cash pile sitting in the Treasury General Account, called TGA. Powell has already taken rates down to almost 0%, and now Yellen just announced plans to reduce the stockpile of cash the Treasury has amassed over the last year.
This means more liquidity at a time when markets are above last-year levels, in some cases, and commodities are more than double-digit higher from their base last year. This is causing some chatter amongst Fed officials -- and for now, the market is unsure what this can potentially mean for equities, risk assets, and more importantly, money markets.
The TGA is like the government bank account, to put it simply, and it raised $1.6 trillion last year during the pandemic that has not been used so far. It is just sitting there.
This money is usually raised by the government by selling T-bills etc. During the quarterly refunding announcement, Yellen announced plans to lower the amount down to $500 billion by the end of June. That is about $1.1 trillion in liquidity that can make its way back into the market over the next four months.
Let's not forget the Fed has been buying Treasury assets to the tune of $120 billion per month since last year. The Fed balance sheet, as of yesterday, now stands at $7.56 trillion, hitting a new all-time high this week. The Fed's total balance sheet rose by $3.4 trillion just last year. But for now, their promise to buy these assets still stands.
Previously, banks would be able to absorb this liquidity and allow their reserve accounts at the Fed to grow dramatically. But the banks do not have the leeway to do this now as they need to manage their liabilities, as well. So, this $1.1 trillion in liquidity needs to find a new home.
The next alternative is the money markets. But therein lies another problem, money market rates are already trading close to 0. This sort of influx can take short-term rates into negative territory. This is something the Fed has wanted to avoid: If these rates go to 0, then the money markets will stop taking in new money.
The Fed may have no choice but to raise short-term administered rates like RRP and IOER (interest on excess reserves). This is all part of the technical plumbing of the market that equity market day traders are blissfully unaware of. The slightest hint of a "rate increase" can send shockwaves down risk assets, and a create higher dollar over the short term.
U.S. 10-year bond yields have been shooting higher over the past week, from 1.15% all the way to 1.33% at time of writing. Most day traders are blindly following the tick higher by chasing the reflation trade even higher, without asking why rates are going up and how far they can go. Outside of the level of the actual yield on the back end of the curve, it is the rate of change that is more worrying than the level per se.
Aggressive, sharp moves are never a good thing for markets to digest. In theory, one can argue the Fed is not concerned about a quickly steepening yield curve, and let the back end move in line with "inflation expectations," as they are bent on letting inflation run hot. Yellen already made loud proclamations that "doing too little" is a much bigger risk to the U.S. economic recovery than doing too much. They are prepared to face the consequences afterwards (i.e. run-away inflation), rather than spend too little to help the recovery.
Their focus lies on the tens of millions of people out of jobs and their sole goal is to get the employment rate back up. Jobless claims moved up another 860,000 for last week. The U.S. job recovery is losing steam, but the real question is whether loose monetary accommodation is the solution, as all it does is push asset prices higher. More money printing is coming, not less, for all the wrong reasons.
We all know from Yellen's background she is ultra-dovish, and would always prefer to print a few extra trillion rather than do nothing. It remains to be seen how Powell handles this new tsunami of liquidity that is about to enter the market. Perhaps during the next FOMC meeting on March 16, the Fed may have some explaining to do -- and perhaps stop the asset buying scheme or raise short-term rates. That is, unless the market totally misreads it beforehand.
