by Wolf Richter, Wolf Street:
The minutes mentioned it. New York Fed’s Perli added some background. The Fed will likely provide details at its March meeting.
By Wolf Richter for WOLF STREET.
No one has ever drained $2.2 trillion in liquidity through QT from the financial markets, as the Fed has done since July 2022, and there is no playbook to go by. Withdrawing liquidity too fast can cause some places to run dry while others are still awash in it. Normally higher yields cause liquidity to move where it’s needed, but if it drains too fast, there may not be enough time for yields to do their job distributing liquidity, and then something blows out, like the repo market did in 2019. An accident like that would cause QT to stop. And the Fed has consistently said it wants to avoid another accident, which is why it slowed QT in June 2024 so that QT can keep going further.
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And now there’s a new potential issue for the Fed – for its balance sheet and liquidity in the financial system: the debt-ceiling fight and the $800-billion checking account of the federal government. When $800 billion in liquidity suddenly pours into financial markets and then vanishes from the financial markets even faster, it moves the needle.
The first official mention came in the minutes of the January 28-29 FOMC meeting: that the FOMC is considering “pausing or slowing balance sheet runoff until the resolution of this event.”
So, not stopping QT entirely, but pausing or slowing it temporarily until the issues of the debt ceiling are resolved.
Then on March 5, the New York Fed’s Roberto Perli, Manager of the System Open Market Account (SOMA), which handles the Fed’s securities transactions, gave a speech about the more distant future of the Fed’s balance sheet, which paralleled what Dallas Fed President Lorie Logan had said a month earlier [Future of the Fed’s Balance Sheet: How Assets Might Shift from Longer-Term Securities to Short-Term T-Bills, Repos, and Loans after QT Ends. MBS Entirely Off the List]. But Perli included a detailed discussion about the near-term issue related to the debt ceiling.
While the debt ceiling is in place, the government cannot raise more cash by issuing new Treasury securities and instead will run down its checking account at the Fed, the Treasury General Account (a liability on the Fed’s balance sheet).
Before the debt ceiling was reached, the TGA had a balance of over $800 billion, which is what the Treasury Department normally wants to keep in it. While the debt ceiling persists, that balance will be drawn down. It has already been drawn down to $530 billion. In past Debt-Ceiling fights, it was drawn down to near zero.
Drawing down the TGA effectively injects liquidity into the financial system, potentially close to $800 billion. But that’s not the problem.
The problem occurs when the Debt Ceiling gets lifted, and the government refills the TGA rapidly by issuing lots of T-bills, which sucks that liquidity back out of the financial system, and very quickly.
Last time, $500 billion got sucked out of the financial system in eight weeks in June and July 2023, and another $300 billion got sucked out over the next 12 weeks, to refill the TGA back to $800 billion by mid-October 2023. That was a lot of liquidity to vanish from the financial system in a short time.
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