Thread by @adaltos59

(1/9) As another round of stimulus hits bank accounts, we are already seeing the impact the waves of money is having on financial plumbing. While certain short-term rates are being pushed negative, a different type of "repo crisis" may be building.

https://twitter.com/AnalystDC/status/1371591207009320968

(2/9) The current round of stimulus is being funded primarily through the TGA drawdown and not new UST issuance. QE is continuing at $120B/mo which drains collateral and replaces it with reserves. Both increase the supply of money relative to collateral.

https://twitter.com/bondstrategist/status/1370174044679630848

(3/9) This excess money has two primary outlets: (1) Deposit at a bank, which can pay IOER less expenses or (2) Deposit with a money fund which can pay RRP rate adjusted for returns & expenses. Currently these rates are zero or slightly positive.

(4/9) However, both IOER and RRP are currently constrained as #zoltan has laid out extensively. IOER requires bank balance sheet space, which is already constrained due to SLR, G-SIB scores, asset caps, and other considerations. RRP is limited by the o/n RRP facility cap of $30B.

(5/9) We are entering an environment where there is too much money with not enough collateral. This is the opposite of the situation that caused the repo crisis in 2019. It will put pressure on short-term UST rates and o/n GC repo rates to go to the ZLB or negative.

(6/9) Primary Dealers are also starting to reduce their inventories which will further decrease demand for o/n GC repo funding and push down rates as their elevated inventory levels have been a large factor in higher o/n GC repo rates.

https://twitter.com/StephenSpratt/status/1370314412276387848

(7/9) With all these factors pushing short-term rates negative, the Fed will need to uncap the RRP facility as it is likely the only outlet for these pressures and they may hike the RRP rate to offer a positive return for money funds.

(8/9) However with the short-end rates pinned at the ZLB, there is a risk that money funds move en-masse to an uncapped Fed RRP facility as it would offer a relatively higher rate and zero counter-party risk. This would further divide the bank & non-bank relationships.

(9/9) As money funds withdraw $ from banks to deposit into the Fed RRP, the banks will need to return securities to sec lenders and hedge funds. This reduces demands for UST & MBS assets and the repo funds available for hedge funds to leverage up.