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Zoltan Pozsar Sees a $1 Trillion Problem for Money Markets Ahead

The Credit Suisse strategist estimates up to $1.3 trillion of Treasury bills could be rotated into the Federal Reserve’s reverse repo facility by the end of August.

Zoltan Pozsar
Photographer: Ryan Duffin for Bloomberg Businessweek

An explosive mix of  excess cash sloshing in the financial system, ongoing quantitative easing and a looming debt ceiling deadline could combine to create a headache for major money markets, according to Zoltan Pozsar.

The Credit Suisse Group AG strategist and long-time Odd Lots guest has earned a reputation for predicting the repo madness of late 2019, and is once again forecasting volatility in a key funding market. At issue is the amount of money that could flow into the Federal Reserve’s reverse repurchase facility (RRP) as money market funds and banks reshuffle their existing holdings to take advantage of a recent increase in interest.

The Fed surprised the market last month by tweaking interest paid on the RRP from nothing to 5 basis points, a move that’s been luring billions of dollars into a facility intended to help the central bank keep a floor under interest rates. Already Pozsar estimates that usage of the facility has jumped by $300 billion since the RRP rate hike as money market funds dump lower-yielding T-bills in favor of parking cash at the RRP.

Now he sees the possibility of more money flowing in:

In other words, Pozsar argues that money market funds are incentivized to rotate out of Treasury bills and into the newly-lucrative RRP, potentially leaving billions of dollars worth of bills that the market will need to absorb, thereby draining reserves from the banking system.

So far that hasn’t been too much of a problem, with shorter-term investors keen to snap up bills ahead of an expected crunch in supply. A reinstatement of the debt ceiling, which was suspended during the depths of the pandemic, is expected to hit supply as the Treasury will have to slash its balance at the Fed to $400 billion before July 31.

But ongoing QE from the Fed ($250 billion in the next two months) will leave some $400 billion that still needs to be drained, according to Pozsar’s estimates. That could lead to market weirdness as banks retool their balance sheets: