JPM Says "The Bills are Back in Town"
Last week, J.P. Morgan's "Short-Term Market Outlook & Strategy" featured a brief titled, "The bills are back in town." It explains, "We think repo markets will remain orderly for three reasons. First, MMF AUMs are still rising and we expect this to continue into year-end, allowing investment in T-bills without reallocating from repo. We think MMF AUMs can reach $7.6-7.7tn by year-end, and there are many other T-bill liquidity buyers, some of which do not engage in repo, that can help take down the bill supply. Second, bank portfolios are underinvested in repo relative to history, with their repo exposure at $710bn or below 3% of total assets, vs. $850bn or ~5% of total assets in mid-2019, though admittedly their exposure has been increasing over the last few months (up ~$75bn).... Third, the SRF remains available as a source of liquidity, and we think primary dealers will have no problem using it when the economics make sense. The morning and afternoon SRF operations also help. As the SRF/TGCR spread narrows, dealers may prefer the Fed as a source of funding compared to MMFs; as the GC/SRF spread widens, dealers may be more willing to intermediate." JPM writes, "As MMFs shift from repo to T-bills and as bank portfolios increase their role in funding, volumes may increasingly anchor around IORB. That said, if we're right, and MMFs continue to grow AUMs (+$100bn over the next 6 weeks) and they absorb 66% of the additional $150bn of T-bill supply, this would suggest that 1) non-MMF participants must absorb the remaining $50bn in supply, which we think is easily digestible, and 2) MMFs may not have to reallocate out of repo and into T-bills, limiting the impact on the funding markets. Based on the above, and factoring in corporate tax day, mid-month coupon settlements, and quarter-end, we think fair value for SOFR/EFFR for September should be around -3.5bp.... Sponsored repos can help reduce cross-jurisdictional scores without pulling back on funding activity, and banks may use other strategies like compressing derivative trades to manage GSIB scores. To that end, we think the pricing for SOFR/EFFR for December (SERFFZ5) might be too narrow currently, but it's not an attractive entry point right now." The piece says, "The latest holdings data revealed that MMFs absorbed a significant portion of the T-bill supply issued in July. Based on our estimates, MMFs took about 66% of the $212bn net T-bill issuance, boosting their allocations by $140bn. Remarkably, this level of absorption mirrors the trend seen after the 2023 debt ceiling dynamic, where MMFs captured around 66% of the total bill supply issuance in the one month following the resolution. Unsurprisingly, government MMFs led the charge, increasing their T-bill holdings by $95bn to reach $1,991bn, while prime funds added $45bn.... From a maturity standpoint, government MMFs extended along the curve last month, adding $323bn in the 31–60 day range and $89bn in the 61–90-day range." It adds, "Despite robust demand for T-bills from MMFs, the repo market remained mostly orderly throughout July, as MMFs' T-bill allocations primarily came at the expense of the ON RRP facility. In fact, MMFs reduced ON RRP balances by $209bn month-over-month to $180bn by the end of July. Meanwhile, MMFs' non-Fed repo exposure surged, climbing $81bn to nearly $2.8tn.... Within this, tri-party repo exposure to U.S. banks (excluding FICC) increased by $54bn, nearing $800bn, while year-to-date repo exposure with U.S. banks (primarily U.S. G-SIBs) grew by $178bn. In contrast, exposure to Canadian dealer repo declined by $84bn during July, likely reflecting balance sheet adjustments around Canadian bank quarter-ends. Allocations to FICC-sponsored repo also rose by $30bn, reaching approximately $1.1tn. Notably, FICC repo exposure is now 40% of MMFs' total repo holdings (ex-Fed), a staggering 10%-pts increase year-over-year, likely driven by dealer balance sheet optimization and the Treasury clearing mandate.... Prime MMFs were also active in the credit markets, boosting bank credit exposure (across U.S., Eurozone, and other Yankee banks) by $31bn to $520bn, and adding $8bn to non-financial CP holdings. Looking ahead, as the TGA rebuild progresses, we anticipate that MMFs will remain the dominant buyers of T-bills. In fact, MMFs seem well-positioned to absorb additional T-bill supply, as their holdings of bills at the end of July accounted for just 28% of total portfolio holdings, below the January local peak of 36%.... With AUMs increasing by $105bn month-to-date to reach $7.4tn, and likely continuing to rise, we anticipate a supportive environment for funding markets in the near term. That said, as reserves continue to be drained to replenish the TGA, SOFR levels should remain a couple basis points above EFFR on average for the rest of August."
