A flood of Treasury bills from the Treasury may force the Fed to halt quantitative tightening.
That’s because too much debt could put pressure on banks’ reserves, economists at the Federal Reserve Bank of St. Louis wrote.
The Treasury Department has issued $1 trillion worth of T-bills since June, and the value of T-bills is expected to reach another $600 billion by the end of the year.
Excessive US debt may force the Fed to halt its policy Quantitative stress Campaign so the financial system does not become unstable, according to economists at the Federal Reserve Bank of St. Louis.
The Treasury Department has issued $1 trillion worth of Treasury bills since June, when the debt-ceiling crisis was resolved, and is expected to reach another $600 billion worth of Treasury bills by the end of the year.
Meanwhile, the Fed stopped buying bonds last year and shrank its balance sheet, leaving bank reserves and money market funds as the main sources of money to buy US debt. But the previous quantitative tightening campaign saw banks’ reserves drop, forcing the Fed to change its stance in 2019 and buy T-bills.
“Although there are currently ample reserves, a lower level of reserves could cause stress in the financial markets.” The economists at the Federal Reserve Bank of St. Louis wrote in a research paper. “So, as the Fed continues into QT-II, it will need to assess when to slow and halt recoveries to avoid draining too much reserves from the banking system and causing a pullback in financial stress.”
The QT program is a strategy to allow maturing bonds to roll back to reduce the country’s money supply. This coincided with an aggressive cycle of rate hikes to bring inflation back to the Fed’s 2% target. Meanwhile, government borrowing has soared as large infrastructure and spending programs ramp up.
Recently, money market funds have been largely on the sidelines of the massive issuance of treasury bills by the Treasury Department. This is because they have been in favor of the Fed’s Overnight Reverse Repurchase Program, or ON RRP, which offers higher returns.
But if too much money flows from banks’ reserves to buy all the US debt that hits the market, lenders may struggle to meet regulatory requirements.
The paper warned that “there is a risk that RRP balances remain large and bank reserves account for the majority of the Fed’s contraction in liabilities as the QT period continues. In this case, regulatory banking restrictions could begin to comply sooner than expected.” “.
Moreover, Fed surveys have indicated that banks prefer to hold more reserves.
And while a St. Louis Fed note estimated that $2 trillion in bank reserves could be the optimal level, the data suggests higher levels.
“Financial markets continue to evolve and desired liquidity may be closer to 10% to 12% of nominal GDP ($2.7 trillion to $3.3 trillion), with the current level of buffers already around the upper end of the estimate,” the note said.
Read the original article at Business interested