Cash crusade: What are banks doing with the cash from quantitative easing?
Until there is a resolution on the debt ceiling, net Treasury bill issuance is likely to remain materially negative in the coming month, putting continued downward pressure on short term interest rates.
Global Market Strategist
Listen to On the Minds of Investors
Previously, we discussed how the Federal Reserve (the Fed) “creates” money and injects it into the financial system. So where has quantitative easing from the COVID-crisis gone? We can look at the Fed liabilities to see where this cash has “manifested” itself. Last year, as highlighted in the chart, the balance sheet grew by $3.1trn1 , with almost half (45%) of that growth being driven by a $1.4trn increase in bank reserves. Another $1.2trn showed up at the US Treasury’s checking account at the Fed (TGA). I cover the gritty details here, but suffice it to say, the TGA and bank reserves are both liabilities at the Federal Reserve. Meaning, when an investor pays taxes to the Treasury, buys US Treasuries at auctions, etc., reserves can leave the system, while the TGA increases. The inverse is true as well, in essence, this transaction shifts one liability item at the Fed to another.
For simplicity sake, let’s assume the asset-side of a commercial bank includes: loans, Treasury and MBS securities, and bank reserves; and on the liability side, mainly deposits. During stressed periods, companies sell securities to increase liquidity and that cash makes its way to commercial banks in the form of deposits2 . Because all balance sheets must balance (A = L+ E), this growth in deposits should result in either: more loans, more reserves or owning more investment securities, assuming retained earnings remains constant3 . Here’s where it gets interesting: the SLR exemption, also discussed here, removed reserves and treasures from the calculation in order to encourage increased lending capacity from commercial banks and to allow sufficient market making in the Treasury and MBS market.
Looking at the growth in Fed liabilities in 2021, the TGA has been drawn down substantially, while bank reserves rose steadily up until March 2021. Since then, reverse repos usage has picked up materially. Buy why? With loan demand weak, and reserves—which continue to rise due to QE— and Treasuries now being included in the SLR, banks have opted to actively try and manage their deposit growth by repricing deposits and/or sweeping some of the excess cash into government MMFs.
As we outlined, the Treasury has not been issuing short-term bonds because it’s been funding its spending through TGA drawdown. The drawdown in the TGA has coincided with an $822bn decline in net T-bill issuance4 , most of which were held in government MMFs. As a result, government MMFs have turned to the RRP facility as a supply backstop. To put it simply, there is too much cash chasing not enough collateral.
In closing, the Fed’s cash crusade will continue to inject cash into the system, even as tapering occurs. Given weak loan demand and current regulation, banks will look for ways to minimize deposit growth, suggesting MMF assets are likely to continue to increase. At the same time, until there is a resolution on the debt ceiling, net Treasury bill issuance is likely to remain materially negative in the coming month, putting continued downward pressure on short term interest rates.
Source: Federal Reserve, J.P. Morgan Asset Management.