The Discount Closed. The Floor Is the Market Now.
There are two prices for overnight cash and this morning they are the same number. One is what a borrower pays against Treasury collateral. The other is what the Federal Reserve pays a bank to hold reserves. For years the first was the cheaper of the two, and that gap was not a curiosity - it was the discount the system paid for the privilege of having somewhere to put cash. This morning the gap is gone. Nothing is scrambling and nobody is paying up, which is the point: the discount disappeared without a stress event to explain it. Underneath that, the facility that used to stand between Treasury issuance and bank reserves is empty, and reserves are draining. Ahead: what closed, what is no longer underneath it, and why the pressure is showing up in rate volatility rather than in funding. The figures sit in the notes; the argument does not need them.
The discount closed
Secured overnight money fixed at the administered rate this morning, and the rate the Federal Reserve pays on reserve balances is the same figure. The spread between the two closed to nothing, from narrowly negative at the end of last week and narrowly negative again on Monday.1
The size of that move is not an event. The direction is. A negative spread is the signature of reserve abundance: cash is plentiful enough that the marginal lender will accept less than the Fed pays on deposits. Once the spread reaches zero, the marginal lender will not accept less any more.1
Nothing is being priced for stress. Overnight cash is clearing without anyone paying up for it, and the composition of the move says the same thing - the market price has risen to meet the administered price, not the administered price dropped away from the market.1,2
What is no longer underneath it
Take-up at the overnight reverse repo facility is down to the best part of a billion dollars, having halved again overnight. A facility that once parked trillions is empty, and the print it moved by is small enough that the level means more than the change.3
Reserve balances fell by more than eighty billion dollars in the week to last Wednesday.4
The Treasury's cash balance at the Fed has been rebuilt toward a trillion dollars, and it moved twenty billion higher in a single day.5
The arithmetic is the one this column set out a week ago and it has not improved. With the reverse repo facility empty, a Treasury cash build has to be funded out of bank reserves or out of money fund balances that would otherwise have been parked at the Fed. There is no longer a parking lot between the two accounts.3,4,5
The front end did the work this time
The front end of the curve did the work. 2 years added the most, the bill sector added least, and everything from the 5yr outward now sits at the top of its own 3yr range.6
The two-to-ten corridor narrowed rather than widened. The front end closed part of the gap rather than the back end opening it further, which is the opposite of the pattern this column has been describing for a fortnight.6,7
The real yield is now within a few basis points of three per cent, and inflation compensation did not move. The nominal added; the breakeven did not. That is a real-rate move wearing a nominal coat.8
The composite headline is fractionally positive and the regime reads neutral on every sub-index. Rates & Policy is the dominant one by a wide margin, Liquidity is the drag, and Credit & Stress and Growth & Inflation are both small negatives.9
The pressure is in volatility, not in funding
Rate volatility had its largest weekly move in this sequence, and equity volatility rose while staying low against its own history. That combination - the front end calm, the vol surface repricing - is the shape of a market that expects the floor to be tested rather than a market that expects a funding accident.10
High-yield spreads widened by the most in a single session this column has recorded, with investment grade following a shorter distance behind. Cash credit was softer across the board and equities sold, with the long bond down alongside them.11,12
A front end arriving at the administered rate, rate volatility at a sequence high and no premium for overnight cash is the combination this column has been describing for 2 weeks. It is no longer a description of what might happen. The discount has closed.
What a closed discount does to the BTC complex
Bitcoin is lower on the day, slightly lower over 5 sessions and higher over thirty. Ether is marginally higher.13
The Strategy common is weaker again on the day and on the week, and now sits in the bottom third of its own range while spot bitcoin sits above the middle of its.14
The preferreds are mixed, with the newest of them pinned at the very top of its range - the coupon closest to cash is the one the market will not let go cheap.15
A closed spread between the secured rate and the rate on reserves is a tightening of the price of the shortest money in the system, and the complex that leans hardest on cheap duration has already been marked for it. The gap between the common equity near the bottom of its range and spot above the middle is the exposure, and it is not new. What is new is that the floor underneath it is now the market rather than the facility.
What would change the read
The first break is the secured rate printing persistently above the rate on reserves. That is the transition from a closed discount to an actual premium for cash, and it is the only line that matters at the very front.1
The second is take-up at the reverse repo facility returning to tens of billions, which would mean the system is parking cash again and the drain on reserves has stopped.3
The third is reserve balances dropping below the level that has held all year, which would take the cushion under the floor with it.4
The fourth is credit. High yield through three per cent with the 10yr above where it closed this morning would move this from a funding story to a credit story, and the two take different hedges.16
Everything between here and those lines is an overnight market trading at the administered rate with no buffer behind it. That is not a forecast. It is this morning's print.
| TENOR | LEVEL | 1D Δ | Z (3Y) | RANGE %ILE |
|---|---|---|---|---|
| 2Y | 4.610 | -0.060 | +1.39 | 78 |
| 5Y | 4.780 | -0.070 | +2.24 | 86 |
| 10Y | 4.980 | -0.070 | +2.51 | 84 |
| 30Y | 5.320 | -0.050 | +1.99 | 83 |
Notes
1. Secured overnight rate (SOFR) fixed at 3.90% on 29 September, equal to the interest rate on reserve balances (IORB) at 3.90%. The spread was -2bp on 28 September and -3bp on 24 September. The effective federal funds rate (EFFR) is 3.88%. Sources: Federal Reserve Bank of New York reference rates; FRED IORB.
2. The spread closed because the market rate rose to the administered rate, not because the administered rate fell: IORB has been unchanged across the period.
3. Overnight reverse repo (RRP) take-up 0.9bn US dollars as of 28 September, from 0.6bn on 25 September. Peak take-up exceeded 2tn. Source: FRED RRPONTSYD.
4. Reserve balances 2,930.2bn US dollars as of 23 September, from 3,013.8bn as of 16 September - a fall of 83.6bn in 1 week. Source: FRED WRESBAL.
5. Treasury General Account 945.3bn US dollars, from 924.6bn on 28 September and 947.3bn on 25 September. Source: US Treasury Fiscal Data, Daily Treasury Statement.
6. Treasury curve, 29 September: 3-month 4.28% (+4bp), 2yr 4.92% (+11bp), 5yr 5.06% (+8bp), 7yr 5.15% (+9bp), 10yr 5.24% (+7bp), 20yr 5.60% (+6bp), 30yr 5.56% (+7bp). Percentile ranks are each tenor against its own 3yr range: 2yr 92.8th, 3-month 34.7th, 5 years and outward at the 100th. Source: US Treasury daily yield curve.
7. 2s10s closed at 32.0bp, from 37.4bp. Source: same curve.
8. 10yr real yield 2.90% and 10yr breakeven inflation 2.34% as of 28 September; the 25 September column carried 2.844% and 2.34%. The nominal added 7bp while inflation compensation was unchanged. Sources: FRED DFII10, T10YIE.
9. Composite headline +0.314, regime NEUTRAL, on 5 of 5 sub-indices. Rates & Policy +1.629; Liquidity -0.499; Credit & Stress -0.213; Growth & Inflation -0.08. Source: this site's composite, 29 September.
10. MOVE 101.82, +5.82 on the day and +20.62 on the week. VIX 16.07, +1.20, 10.4th percentile of its range. Source: exchange closes, 29 September.
11. ICE BofA US High Yield OAS 2.93% as of 25 September, from 2.80% on 24 September. Investment grade 0.81% from 0.79%. Source: FRED BAMLH0A0HYM2, BAMLC0A0CM.
12. 29 September closes: HYG 77.54 (-0.32), JNK 93.16 (-0.45), LQD 102.47 (-0.74), TLT 78.62 (-0.70); S&P 500 7,683.69 (-59.72); Nasdaq 100 30,276.81 (-331.32). Source: exchange closes.
13. Bitcoin 83,976.00 US dollars, -482.09 on the day, -0.63% over 5 sessions and +7.17% over thirty. Ether 2,705.71, +18.78. Source: spot closes, 29 September.
14. MSTR 157.14 US dollars as of 28 September, -1.47 on the day, -11.36 on the week, 28.5th percentile of its range; spot bitcoin 58.3rd. Source: exchange closes.
15. STRF 103.55 (-0.11), STRK 75.15 (+0.26), STRC 99.10 (+0.56), with STRC at the 100th percentile of its range. Source: exchange closes, 28-29 September.
16. Invalidation levels: high-yield OAS through 3.00%; 10yr above 5.15%; RRP above 50bn US dollars; reserve balances below 2,900bn on the 23 September basis.