The Treasury stated in its refunding statement that it will reduce the Treasury General Account (“TGA”) to $800 billion by quarter-end, an $800b decline from where it is today. The TGA is the Treasury’s checking account at the Fed (like commercial banks, the Treasury has a Fed account and can hold central bank reserves). When the TGA is run down, that liquidity will enter the financial system as reserve assets for commercial banks (balanced by deposit liabilities to non-banks), and deposit assets for non-banks. This post briefly introduces the TGA, explains the mechanics of the upcoming decline, and discusses how the huge influx of liquidity could affect markets.
What is the Treasury General Account?
The TGA is the Federal Government’s checking account at the Fed. Like any other entity, the Treasury needs a place to keep its money. Since the Financial Crisis the Treasury has kept its money at the Fed, which is a risk free counterparty. (Before the Financial Crisis the Treasury actually kept accounts at various commercial banks through a special program called Treasury and Tax and Loan Program). The TGA account has since balloon then in-line with growing government expenditures, as the Treasury’s aims to keep a cash buffer to meet 5 days of outflows. But the TGA really exploded last year in anticipation of an imminent multi-trillion dollar stimulus that is still being discussed. Currently, the TGA is around all time highs of $1.6 trillion.
Recall, we live in a two-tiered monetary system where entities (mostly commercial banks) who have accounts at the Fed pay each other in special money called central bank reserves, and everyone else transacts in bank deposits. When the TGA decreases, those reserves go into the commercial banking system, and increase the banking system’s reserve assets and bank deposit liabilities. This is also why QE boosts M2.
There are two ways the TGA can decline: the Treasury can use the money to paydown debt or it can spend it on goods and services. These two ways have different impact on rates and economic growth. The refunding statement suggests that part of the decline will be paying down bills, and part will be fiscal spending. Note that the Treasury is also adjusting its liability profile in the background – fewer bills and more coupons – thus steepening the curve as described before.
The TGA began 2021 with a balance of around $1.7 trillion and $800b target on March 31st. That implies a net decline of $900b over the quarter, of which $421b is being spent to pay down bills.
TGA is Spent on Debt Repayment
The Treasury issues coupons on a predictable schedule and uses bills to manage fluctuations in cash flow, such as sharp reductions in the TGA. The refunding statement suggests that around $400 billon in bills will be paid down. This means money is going to be returned to money market investors. There are around $5 trillion in bills outstanding, with money market funds holding almost half of them and the balance held across a wide range of investors.
Money funds have very limited investment options, especially if they are government money funds. There are two main types of money market funds: Government funds and Prime funds. Government funds (about $3.7 trillion of the $4.3 trillion money fund space) can only buy government backed debt like Treasury bills, agency debt, and repo backed by Treasuries or Agency MBS. Prime funds invest in the same, but are also able to invest riskier assets like commercial paper or bank deposits. When there is not enough assets for them to invest in, money funds have the option of lending money to the Fed through the Overnight Reverse Repo Facility (“ON RRP”), which is currenting offering 0%. This Facility is how the Fed puts a floor on interest rates.
Back in 2016, the implementation of Money Market Reform led $1 trillion in assets to move from Prime funds to Government funds. Government funds suddenly couldn’t find enough risk free assets to buy so they began dumping money into the ON RRP – sometimes hundreds of billions. During that time overnight repo rates often traded at the ON RRP level as money funds were unwilling to lend at rates below the ON RRP offering rate. Overnight unsecured rates traded slightly above the ON RRP rate, but bill yields often traded below the ON RRP floor. This was because some investors did not have access to the ON RRP, but also needed a place to store their money. These investors bought bills even though they were below the ON RRP rate.
Fast forward to today, when the Treasury is about to return a few hundred billion back into the money markets by spending its TGA balance to pay down Bills. That will put downward pressure on front end rates as money funds find places to invest that money. If there aren’t enough assets to buy, they will just invest it into the ON RRP. (Some commentators have suggested that the Fed’s $30b cap per ON RRP counterparty should be lifted, but the current ON RRP participation of $0 suggests the cap is not binding). Overnight repo rates may again be floored at the ON RRP offering rate. (btw there is no chance the fed funds rate will be 0. Everyone who can lend in the fed funds market has a Fed account. They either earn 0% (GSEs) or 0.1% (IOR for banks)).
The difference this time is that the ON RRP rate is 0%, so should bills trade below the ON RRP rate again they will be negative. This will primarily affect investors who don’t have access to the ON RRP and a subclass of government money funds called Treasury money funds that are not allowed to invest in repo (only bills). These investors may lose money on some of their bill investments. That either means the fund managers will be forced to waive their fees and eat the cost, and/or their investors will deposit money into a bank rather than accept negative returns. Too much liquidity in the system hurts profitability, but it is not destabilizing; quite the opposite, it zombifies money markets.
In any case, Treasury will see that bill yields are negative and start to issue more in that space to take advantage of the anomaly. With an estimated $1.9 trillion in stimulus coming and likely more afterwards, the market will have eventually have all the bills it desires.
TGA is spent on Goods and Services
The other way that money is leaving the TGA is via government spending, which enters the financial system via a very different route. Whereas bill paydowns put liquidity into the money markets (largely money market funds), fiscal spending puts money into the banking sector (and boosts GDP as the Gov spends on goods services, rather than debt repayment). When the Federal government buys stuff they pay someone by depositing money into the seller’s bank account – so the liquidity ends up being in a commercial bank. This increases the level of central bank reserves in the banking system. (Recall we have a two-tiered money system, where those with Fed account transact in reserves and those without transact in bank deposits).
Under Basel III commercial banks are subject to regulatory ratios that limit the size of their balance sheet (the Supplementary Leverage Ratio and Tier 1 Leverage Ratio). This forces a bank to optimize their asset holdings for maximum profitability. Holding too many reserves (currenting yielding 0.1%) is bad for profitability. Banks can manage their balance sheet size by by pushing out depositors. For example, a bank may offer a hedge fund customer a -0.1% deposit rate to chase them away. (The regulatory costs a bank faces varies in part according to the types of depositors it has, where fast money depositors incur higher regulatory costs).
Thus boundless liquidity may force banks to offer some of their clients negative rates to either discourage their deposits, or make it worth the bank’s while. Note that a bank charging depositors -0.1% would be able to deposit those money at the Fed for 0.1% IOR, for a spread of 0.2%. In 2014 or so some Prime funds were charged negative rates by their custodian banks (this can be seen in SEC Form NMFP data).
Right now commercial banks would have not have a problem holding that extra liquidity, in part because the Fed temporarily relaxed some of the rules that would otherwise discourage a bank from holding a ton of reserves (the ECB did the same). This temporary reprieve is scheduled to end March 31, but it is difficult to see how it could expire.
The fact is that on-going QE generates large levels of reserves that the banking system must hold. Not just the few hundred billion from the TGA in the coming weeks, but the trillions more coming from on-going QE. Furthermore, reserves are risk free and the most liquid asset possible, so large reserve holdings make the banking system more resilient. If the Fed does not continue regulatory relief (or even expand it) then some bank deposit rates will go negative (some indication this is already happening, see slide 20), otherwise the banking system would easily absorb the liquidity.
Bottom Line
A massive drawdown in the TGA is going to put downward pressure on front-end rates, but it’s no big deal. Repo, as expressed by SOFR, may be floored at 0 while the funds rate trades slightly above that. USD FX swap basis may narrow a bit as commercial banks deploy their additional reserves into the market for a little extra return. Short dated bills may trade negative until the expected $1.9 trillion is passed and bill issuance picks back up.
The real show is the fiscal spending that is happening. How money enters the system matters. The refunding statement implied around $1 trillion in deficit spending this quarter ($270b in net debt issuance on top of the TGA drawdown). This is full on helicopter money spending, because the Treasury is never going to pay that back. Permanent QE is the same as debt cancellation.