by mark000
Some article on FT:
- The Fed has already started down the path to resuming quantitative easing. The question is whether they do so before, or after, upending the highly-leverage hedge fund basis trade that has been supporting the Treasury market.
- This time around, QT has been complicated by the presence of large amounts of money market fund cash sitting in the Fed’s Overnight Reverse Repurchase Facility, or ON RRP.
- This has created the possibility of a worrying chain reaction – from the Fed’s balance sheet, via the money market funds and the private repo market, through the basis trade and on to the demand for Treasuries, at a time when the US government is coming to market with massive amounts of issuance. Instead of scarce bank reserves creating liquidity problems and forcing the Fed to stop QT, it may well be the exhaustion of the ON RRP and the upending of the hedge fund basis trade that causes problems in 2024. The worrying difference now is that there is no Fed backstop for hedge funds and the high degree of leverage used in the trade could lead to liquidity problems proliferating even more quickly through the financial system.
- It seems unlikely that the Fed is unaware of this issue. Indeed, it may be no coincidence that Fed messaging on QT is already shifting, with Dallas Fed President Lorie Logan already suggesting that QT should taper once the ON RRP runs dry.
- This may be too late to avert a severe bout of bond market volatility, though.
- Either way, the Fed is on course to end QT and restart QE in the coming months, against a backdrop of loose fiscal policy and a still-resilient economy, opening the door to a reappearance of inflationary pressures that the Fed may have little appetite (or ability) to restrain.