Short-term debt "Peak" is drying up! This issue may threaten the Fed's QT reduction

Half a year ago, Wall Street was discussing the issuance of trillions of dollars in short-term US Treasury bonds by the US Treasury The Danger of "Pumping" Out. Now, short-term bond investors are facing a completely opposite challenge: with the decrease in the Treasury's sale of short-term bonds, they are left with a large amount of cash on hand to consider investment destinations.

Currently, traders are worried that the continuous reduction in the supply of short-term bonds in the market may be far below the demand, thereby disrupting the money market. Two years ago, the mismatch between the supply and demand of short-term bonds prompted investors to deposit trillions of dollars into the Fed's reverse repurchase tools to withdraw liquidity. This time, as the Fed considers ending the reduction of its balance sheet (QT), the issue of short-term bond supply may disrupt the Fed's path to removing quantitative tightening (QT).

The US Treasury's future quarterly refinancing bond issuance plan announced at the end of January estimates that the short-term bond issuance in April will decrease by $100 billion to $150 billion. However, within one month in April, the actual issuance of short-term bonds decreased far more than expected, with a net issuance of -$19.6 billion.

This Wednesday, the Treasury will announce a new quarterly refinancing plan, which is expected to indicate that the issuance size of short-term US Treasury bonds from May to July will further decrease. Wells Fargo and Goldman Sachs respectively predict that the net supply of short-term bonds in the second quarter will be reduced by $321 billion and $250 billion. Bank of America even expects a reduction of $401 billion.

Mark Cabana, head of US rate strategy at Bank of America, believes that there is indeed a significant risk of severe imbalance in the supply and demand of short-term bonds, calling it a "shocking" risk as it "completely overturns the logic of 'who will buy all the US Treasury bonds?'".

With the shrinking supply of short-term bonds, where will the large amount of cash go? Based on past experiences, when there is a shortage of short-term assets, the Fed's financing tools will "attract funds".

Due to the US government's massive stimulus after the outbreak of the COVID-19 pandemic and the Fed's super QE, by mid-2022, the excess liquidity in the financing market was reflected in the Fed's reverse repurchase tool RRP, which exceeded $2 trillion, reaching a historical peak of over $2.5 trillion by the end of 2022. The funds held in RRP accounts remained around $2 trillion thereafter, until the Treasury issued a large amount of short-term bonds last year to "pump out" liquidity. From June last year to this month, approximately $1.75 trillion flowed out of RRP. This month, Wall Street News mentioned that the overnight RRP tool usage has dropped below $400 billion for the first time in nearly three years.

The decline in excess liquidity reflected by the RRP tool is concerning. Before the financing market begins to collapse, to what extent can the Fed continue its QT action of reducing its balance sheet? At the press conference after the monetary policy meeting last month, Fed Chair Powell reiterated that the Fed will slow down the pace of balance sheet reduction and stated that the reduction of QT will happen "soon" Currently, Wall Street generally expects that the Federal Reserve will announce its plan to slow down the balance sheet reduction after the monetary policy meeting this Wednesday. However, there are different predictions on when to start the slowdown.

The Federal Reserve has previously stated that it is monitoring the RRP to assess whether the market has sufficient liquidity. If short-term debt investors with a large amount of cash deposit their funds into RRP accounts, it may lead to a lack of clear understanding of liquidity by the Federal Reserve, making the situation of ending QT chaotic. Bank of America's Cabana believes that based on the Federal Reserve's assessment of RRP, it can be argued that, given the supply-demand imbalance, perhaps the Fed should maintain QT for a longer period