Monthly Cash Commentary December 2019

Fortunately for everyone, the month of December could be described as boring. All eyes were focused on the repurchase agreement (repo) market. Starting in September, after the now infamous spike in repo funding levels, clients have called asking what happened, why it happened, was it preventable, what’s being done to prevent it from happening again and what about yearend? Fortunately, all those questions were easy to answer, particularly the last one, as the Federal Reserve (Fed) took considerable action to prevent any volatility in repo funding rates going into the end of the year. Specifically, the Fed added approximately $414 billion of liquidity into the markets to prevent any scarcity. Term repo totaled $211 billion (the Fed lent cash and received US Treasury collateral with the majority of terms between 13- and 15-day maturities with one being as long as 32 days. The Fed exercised $44 billion in overnight repo on December 31. A full schedule of operations can be found on the Federal Reserve Bank of New York’s website.

Concurrently, the Fed was buying US Treasury bills in their “this is not quantitative easing” program. This program was intended to reduce the supply of bills in the market place, add reserves and reduce yields on short-term instruments to corral overnight rates (repo, reverse repo and Fed Funds) into the Fed’s short-term target rate range, which is currently 1.50–1.75%. As of December 31, the Fed reports owing $169 billion of short-term bills, an increase from zero in mid-August. The full list of System Open Market Account (SOMA) holdings can again be found on the Federal Reserve of New York’s website.

Let’s not forget that prior to the new monetary policy framework which was established in 2008, the Fed owned a considerable amount of the US Treasury bill outstandings in their SOMA. In fact, approximately 37% of their holdings were in Treasury bills. At the start of 2008 that level dropped, reaching 0% until this purchase program began. Still, US bill holdings only make up 5% of the Fed’s SOMA account. It’s quite possible the Fed continues to increase its holdings of US bills or other short notes to manage short term rates.

Not to be forgotten, the Fed did have its FOMC meeting and voted for no change in rates as was anticipated. Their tone was optimistic on the economy, removing ‘uncertainty’ when describing economic outlook. The dots remain unchanged for 2020, with one hike forecasted in 2021 and one more in 2022. There was no real reaction from the markets as other economic events– notably the trade deal with China– had a larger impact. The US President announced a phase one deal had been reached and indicated negotiations were already underway for phase two.

The pending tariffs set for December 15 were not implemented and US Treasury yields rose on
the good news. Unfortunately, we didn’t get too far into the month of January before uncertainty returned with the killing of Iran’s General Soleimani. We did see a small 2 basis points (bps) move downward in 3-month bills, and a larger move in 10-year yields, down 10bps. Credit spreads were slightly wider, and volatility increased. It is much too early to determine longer term impacts that these bubbling tensions will have on markets.