Liquidity Pressures Build as Settlements Rise and Reserves Decline
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What a boring day. Expectations were for Nvidia to move by around 6%, but instead, it hardly budged, remaining around $180. Still, the S&P 500 rose by 30 bps, while implied volatility fell sharply. In theory, given the size of the drop in the VIX-1 day, the move higher could have actually been bigger—as noted yesterday, it implied a potential gain of up to 1%.
Treasury bill settlements have been quiet this week, with $45 billion and $26 billion so far. Tomorrow brings a $36 billion coupon settlement, but the larger event comes on Tuesday, with a combined coupon and bill settlement of $140 billion — a sizeable amount compared to recent weeks. The key difference is that next week, the reverse repo facility will have nothing to offer and will not serve as a source of liquidity to fund the settlements.
As of August 27, the TGA stands at just below $600 billion, leaving approximately $250 billion still to be replenished to $850 billion. The first $200 billion of the refill was largely offset by the reverse repo facility, while the second half of the refill is expected to come from reserve balances.
Those effects are now becoming visible, with reserve balances at the Fed falling from roughly $3.3 trillion last week to $3.216 trillion this week. Reserves remain on track to reach about $2.9 to $3.0 trillion by the end of September, which would take them back to the lows last seen in the fall of 2022.
I know many assume we are in a period of fiscal dominance and that is driving asset prices higher, but the truth is, we really don’t know. It could be fiscal dominance, or it could simply be the draining of the reverse repo facility that provided the liquidity to fund the fiscal dominance, which helped to lift stock prices. Equity prices clearly struggled once the Fed ended QE in early 2022 as the repo facility was rising, and they certainly benefited as the reverse repo facility began to drain in mid-2023.
We’ve now entered a period we really haven’t experienced since Covid, when the Fed launched its “QE infinity” experiments.
So we are going to start finding out more, I would think pretty shortly.
-Mike
Glossary
Basis Points (bps) – A unit equal to one one-hundredth of a percentage point, commonly used to describe interest rate or yield changes.
Coupon Settlement – The payment date when Treasury securities that pay interest (coupons) are settled and cash is exchanged between buyer and seller.
Equity Prices – The market value of shares of stock representing ownership in a company.
Fiscal Dominance – A situation where government fiscal policy, such as borrowing and spending, influences central bank actions and financial conditions more than traditional monetary policy.
Implied Volatility – The market’s forecast of future price fluctuations, derived from options pricing.
Liquidity – The availability of cash or easily tradable assets in the financial system.
QE (Quantitative Easing) – A central bank policy of purchasing securities to inject liquidity and lower interest rates.
Repo Facility (Repurchase Agreement Facility) – A mechanism through which the Fed lends cash in exchange for collateral, usually Treasury securities, to manage short-term funding needs.
Reserve Balances – Deposits that commercial banks hold at the Federal Reserve, used to settle payments and meet regulatory requirements.
Reverse Repo Facility – A tool where the Fed borrows cash from counterparties in exchange for securities, temporarily draining liquidity from the financial system.
TGA (Treasury General Account) – The U.S. Treasury’s operating cash account held at the Federal Reserve, used to manage government payments and receipts.
Treasury Bill Settlement – The process of exchanging cash for newly issued short-term U.S. government debt securities.
VIX-1 Day – A short-term volatility index measuring expected stock market fluctuations over the next day, derived from S&P 500 options.
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