Among the many considerations the Federal Reserve (the Fed) has to take in managing monetary policy, the behavior of the Treasury Department can be one of the more challenging. The Treasury Department holds its cash on deposit in the Treasury General Account (TGA) at the Fed. As shown, after a decade of running a relatively small cash balance, in order to cover unforeseen pandemic-related relief, the Treasury issued a whopping 2.4 trillion USD¹ (net) in T-bills in the second quarter of 2020, which expanded the TGA to a peak of 1.8 trillion USD. As it turns out, this left the Treasury with a significant cash balance through the end of the year that currently sits at 1.6 trillion USD².

As the Treasury looks to draw down the TGA to fund further stimulus and to normalize its cash balance to pre-pandemic levels, this shift could cause some volatility in short term rates, complicating how the Federal Reserve sets monetary policy in 2021. Importantly, investors should recognize that because the TGA is held at the Fed, it is considered a liability to the Fed. As a result, changes to the TGA balance have a direct effect on reserves in the banking system. All else equal, a reduction in the TGA increases reserves in the banking system, while shrinking the available collateral in the short term Treasury market, which is critically important for repo activity in the overnight lending market³. Therefore, in order to reduce the TGA, two things have to happen:

1. Treasury will need to effectively cease issuing short-term paper to avoid building the TGA; and
2. Move the existing funds from the TGA into the accounts of depository institutions. In other words, shifting dollars from one liability item at the Fed to another.
   
   

With excess bank reserves set to balloon not only due to the TGA drawdown, but also the steady growth of the Fed’s balance sheet through asset purchases, banks will be flush with excess cash and will want to put this cash to use.  This, in turn, could put downward pressure on short term yields and potentially act as a tailwind to credits, like agency mortgage-backed securities, as banks look to hold more higher yielding, high quality liquid assets (HQLA’s).

For investors the TGA drawdown has two macro implications:

1. Money market rates may come under pressure, penalizing savers; and
2. The wave of liquidity expected to be released could prove inflationary if credit demand is strong, potentially pushing long-term rates higher than many expect.
   
   

While these are risks, the Fed could react effectively in avoiding a shock to markets by:

• Extending the Treasury exemption in the supplementary leverage ratio (SLR) for banks⁴, and
• Adjust the interest rate paid on excess reserves (IOER)⁵ slightly higher in order to keep short term rates from turning negative, but still close to zero.

The Fed could easily enact the first option, however, the second could be perceived as a tightening of monetary policy at a time when the Fed is professing an accommodative stance, even if this would only be a technical adjustment. All things considered, we expect the Fed to continue to monitor the situation closely and make the necessary adjustments to avoid a significant repricing in short term rates.

U.S. Treasury General Account

USD billions, week average, balance

Source: FactSet, Federal Reserve, J.P. Morgan Asset Management. Data are as of February 18, 2021.

¹ SIFMA – US Treasury Securities Statistics

² As of February 12, 2021.

³ For a deeper analysis of the flow of funds, refer to Fiscal Flow Volatility and Reserves blog post by the Fed.

⁴ On May 15, 2020, the federal banking agencies issued an interim final rule to permit depository institutions to exclude from their supplementary leverage ratio (“SLR”) denominators through March 31, 2021 the balance sheet value of U.S. Treasury securities and funds on deposit at a Federal Reserve Bank.

⁵ The IOER is the rate the Fed pays depository institutions for parking their excess reserves at the Fed. 

0903c02a82b05a10