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On July 31, 2013, an eagle atop the US Federal Reserve building’s exterior in Washington. Jonathan Ernst/File Photo/REUTERS Reuters, NEW YORK, July 2 – The United States’ debt ceiling will be raised by the end of July, placing pressure on the Treasury to reduce its cash position before the deadline. More cash injections into a financial sector already awash in liquidity could cause short-term rates to fall and money markets to become more distorted. Nearly a trillion dollars in cash poured into the Federal Reserve’s reverse repo (RRP) facility on Wednesday, a new high. Reverse repo volumes fell to $742.6 billion and $731.5 billion on Thursday and Friday, respectively, from their highs. The Fed made a technical adjustment to the interest rates it regulates last month, raising the rate paid to banks on excess reserves (IOER) kept at the Fed to 0.15 percent from 0.10 percent and raising the rate paid on reverse repos to 0.05 percent from zero. WHAT IS THE REVERSE REPO WINDOW OF THE FED? The Federal Reserve introduced the reverse repo program (RRP) in 2013 to absorb excess cash in the repo market and provide a hard floor under its policy rate, or effective fed funds rate, which is currently set at 0% to 0.25 percent. On an overnight basis, eligible counterparties lend cash to the Fed in exchange for Treasury collateral. WHAT IS THE RELATIONSHIP BETWEEN THE CASH SURGE AND THE DEBT CEILING? Due to the Fed’s asset purchases as part of quantitative easing and the US Treasury’s financial support for the economy in reaction to the epidemic, the market is presented with an excess of cash in the banking system. Before a two-year debt ceiling suspension expires on July 31, the US Treasury must reduce its cash balance in the Treasury General Account (TGA) deposited at the Federal Reserve to a target of $450 billion. find out more According to Wrightson ICAP data, the Treasury has a cash balance of $711 billion as of June 29. A drop in the TGA enhances banking system reserves, which have now poured into the RRP market. ARE YOU CONCERNED ABOUT REVERSE REPO VOLUMES? Because Treasury bills’ rates are fixed at lows, an increase in the RRP could lower money market funds’ desire for them. For example, 3-month T-bill rates in the United States are now hovering around 0.05 percent. The transition from bills to RRPs will take time, according to Zoltan Pozsar, Credit Suisse’s global head of short-term interest rate strategy. Bills are now underwater, which means they can only be sold at a loss. “However, it will happen,” he stated. Investors are also watching to see if the amount of reserves and deposits that banks may lose as a result of the RRP facility is substantial enough to wreak havoc on interest rate markets. Bank outflows, according to Lou Crandall, Wrightson’s chief economist, are not yet an issue. If banks are afraid that large outflows may occur as a result of money market funds earning 0.05 percent at the RRP facility, he says they can match that rate to keep their deposits. Gertrude Chavez-Dreyfuss contributed reporting, while Alden Bentley and Andrea Ricci edited the piece. The Thomson Reuters Trust Principles are our standards./nRead More

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