From Fed Guy, April 11:
The $1.7t in the RRP can help finance the upcoming deluge of coupon Treasuries, but it won’t be easy. Treasury bills will easily be funded, but the bulk of the upcoming supply from net issuance and QT is likely coupons. There are only two ways the RRP can finance coupon Treasuries: 1) funding repo loans to leveraged Treasury investors or 2) funding money fund redemptions to cash Treasury investors. Both mechanisms are subject to frictions that suggest a messy process. Leveraged investors may encounter dealer balance sheet constraints, and cash investors may need a much steeper curve. In this post we describe the two mechanisms and highlight the potential for an “air pocket” in the Treasury market where the marginal buyer is many, many ticks away.
Leveraged InvestorsThe pipes through which RRP money flows to leveraged Treasury investors may not be wide enough to finance upcoming supply. Leveraged investors are “fast money” investors who can quickly borrow large sums of money to take advantage of market dislocations. Money flows to them through dealer balance sheets, which are the main “pipes” of the financial system. Cash investors lend to dealers, who relend to leveraged investors, who then use the cash to purchase Treasuries. This transaction “expands” a dealer’s balance sheet because it adds both a repo asset (loan to hedge fund) and a repo liability (loan from cash investor). In theory, money market funds (“MMFs”) can shift their investments out of the RRP and into repo loans that end up funding Treasury purchases. But in practice, balance sheet constraints will limit this flow....
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There is a chance of a nasty spike in rates up ahead.
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