Is this the global macro landmine no one is talking about?

While all eyes are on the recent rise in yields, the debate has largely been centered around inflation expectations and how far the Fed will actually let inflation run before raising rates. While all this is all very interesting and sounds smart and logical, there is a much more concerning issue, deep within the technical plumbing of money markets, that equity traders are mostly unaware of.

On February 23rd 2021, testifying before congress, Jay Powell was asked the following question, and his answer, although somewhat vague, should have warranted a much more intense interrogation.

Question: Senator Rounds: It would appear Congress is going to create even more bottlenecks in our financial plumbing by flooding the economy with about $1.9 trillion in new money, that banks will have to hold capital against as soon as the treasury starts writing the checks. My question is would you agree that it makes sense to seriously consider extending the SLR exclusion, given the other measures the Fed and Congress are taking to facilitate our economy’s recovery?

Answer: Jerome Powell: So I do think that the SLR exclusion, I know it expires at the end of March, and we actually haven’t made a decision on what to do. It’s something we’re in the middle of thinking about right now. And so I’m just going to have to say that we’ll be making a decision in announcing pretty soon here.

So what is the SLR? 

The supplementary leverage ratio, or SLR, requires banks with more than $250 billion of assets to maintain an extra cushion of high-quality capital against their total assets. Banks must maintain a minimum 3% ratio against their total leverage exposure. The ratio is 5% for the largest bank holding companies. In April 2020, the Fed allowed U.S. Treasury securities and deposits held by commercial banks at Federal Reserve Banks to be excluded from the calculation of total leverage exposure for purposes of the supplementary leverage ratio. This exclusion however, expires on March 31st 2021.

And, why does this matter?

Its all related to the Treasury’s General Account, the TGA, which is essentially the governments bank account that holds the proceeds of selling T-bills. The proceeds are a liability on the government balance sheet and the funds are supposed to be spent on government bills, stimulus payments and anything they need to fund. Former Treasury Secretary Steve Mnuchin allowed the account to skyrocket to $1.6 trillion. To put this into perspective, the account generally held ~$5bn prior to 2008, and more recently between ~$150bn on average.

Current Treasury Secretary, Janet Yellen recently outlined plans to reduce the TGA account (remember it is a liability) from $1.6trillion to $800 billion by the end of March, and then further to $500 billion by the end of June. That’s a whopping $1.1trillion of liquidity that is being unleashed into the system within a very short time frame. So big, it has been dubbed a “tsunami of liquidity” into the economy. 

10yr vs 3mth yields: While 10yr rates are rising, short term rates have been trading lower, the risk is a test of 0%, and potentially negative rates: