In September 2019, the financial markets experienced a significant event with the EFFR (Effective Federal Funds Rate) and SFOR (Secured Overnight Financing Rate) rates shooting up. These rates are crucial indicators of liquidity in the financial system.
The trouble began in September 2019 when the EFFR surged to levels significantly above the target set by the Federal Reserve. This sudden spike was primarily due to a combination of factors simultaneously occurring. First corporations and other entities had to make quarterly tax payments, leading to a drain of liquidity from the banking system. Second, the supply of cash in the market was constrained due to the U.S. Treasury’s issuance of new bonds to finance the increasing budget deficit replenishing the TGA account at the Fed. Third, a large amount of Treasury debt was settled also at the same moment, which increased the Treasury holdings of primary dealers buying at auctions and financing them through the repo market. As news of the escalating rates spread, investors grew anxious about the potential consequences.
What are the parallels with today?
1. A lot of debt will be maturing at or soon after the X-date. Just T-bills we are looking at over 100B.
2. The Treasury will have to rebuild the TGA account quickly as it sits under 40B to the tune of nearly 700B in weeks.
3. The next quarterly corporate tax date hits June 15 which will be draining deposits at banks.
4. Banks reserves have already fallen by 1.3T since the peak in December 2021 and sit under 3T as MMF is growing with strong demand from retail investors making the drawdown from reserves more likely than from MMF as banks get close to HQLA minimums.
5. Foreign buyers came in March and May as the banking hit but were soft previously. If foreign buyers don’t step up as more issuance hits then primary dealers would have to take up more slack and finance them through the repo market.
6. Banks have stabilized but issuance of new debt at higher yields could worsen their AOCI losses on existing holdings at low rates. Would rather have 5% T-bills or 1.5% 10-year bonds from 2021?
In 2019, to address the liquidity shortage, the Federal Reserve injected cash into the system by purchasing short-term securities. I am not so sure the Fed will do this significantly and would just tell the banks to head over to the BTFP and repo market at high rates.
The next few weeks to months could be very volatile for banks, primary dealers, and rates. If banks don’t manage the onslaught listed above they could very well get into more liquidity issues. This is of course before the June meeting of the Fed that is more likely to hike again.
Good luck everyone!
If you want to learn more about what happened in 2019 I suggest reading the paper from the Fed below:
