Mark Cabana on the Fed, QT and Treasury Funding

Episode Summary

Executive Summary: The episode centers on whether the Fed’s QT and Treasury supply are still major market drivers versus macro data, and how bank liquidity demand may constrain balance sheet reduction. Guest Mark Cabana argues the Fed is more likely to slow QT by mid-to-late summer as reserves and the overnight RRP decline, because banks now want much more cash for prudential, regulatory, and funding-market reasons.

Main Topics: Fed week, jobs data, and Treasury quarterly refunding (Priority: 5/5): The hosts frame a packed macro week: the Fed meeting, payrolls, and Treasury’s quarterly refunding announcement, with markets closely watching policy signaling and debt issuance plans. Treasury supply and term premium (Priority: 4/5): Cabana says refunding announcements matter for market sentiment and term premium, but they are secondary to growth, inflation, and the expected Fed path. Who buys Treasuries in 2023–2024 (Priority: 5/5): The discussion covers shifting demand from banks, pensions, insurers, foreign investors, asset managers, and the Fed, with demand returning as inflation peaking and rate hikes ending became clearer. QT, reserves, and the overnight RRP as liquidity gauges (Priority: 5/5): The episode argues that QT can continue while excess cash remains in the system, but the overnight reverse repo facility is a key indicator for when liquidity is getting tight enough to slow QT. Bank liquidity preference after SVB and higher rates (Priority: 5/5): Banks are said to want materially more overnight liquidity because of the regional banking stress, unrealized securities losses, changing liquidity rules, and reduced reliance on home loan bank funding. Repo market plumbing and year-end volatility (Priority: 4/5): Short-term repo spikes are explained as a cash-versus-collateral imbalance amplified by month-end/year-end balance sheet constraints and large Treasury settlements. Fed balance-sheet costs and political implications (Priority: 4/5): Cabana explains the Fed’s negative net interest margin and deferred asset, noting the real fiscal cost of paying high rates on reserves and RRP while earning lower yields on its assets.

Key Arguments: Treasury refunding supply matters, but macro data and the expected policy path matter more for rates than issuance mix alone. The narrative that QT mechanically drives equities lower has been disproven by the rise in stocks even as the Fed has been shrinking the balance sheet since mid-2022. Investor demand for Treasuries weakened in 2023 but returned as inflation cooled and the Fed’s hiking cycle neared its end. Banks are demanding more cash liquidity for rational reasons: SVB, unrealized losses, regulatory change, and uncertainty around funding alternatives. The overnight RRP is a better indicator of excess liquidity than reserves alone for deciding when to slow QT. Repo-market stress reflects cash/collateral imbalances and seasonal balance-sheet constraints, not necessarily a permanent structural breakdown. The Fed faces a real cost from a large balance sheet because it pays more on liabilities than it earns on securities, creating negative NIM and a deferred asset.

Data Points: Fed balance sheet: about $7.75 trillion - Cabana cites the current size of the Fed’s balance sheet while discussing QT path. Expected Fed balance sheet after QT slowdown: about $7.5 trillion - Cabana’s forecast for where the balance sheet may end up by mid-to-late summer. Fed interest on reserve balances rate: 5.4% - Rate paid to commercial banks on reserve balances, used to explain Fed losses. Fed overnight reverse repo rate: 5.3% - Rate paid on the overnight RRP facility, another major Fed liability cost. Fed liabilities tied up at the Fed: close to $4 trillion - Combined reserves and overnight RRP balances held at the Fed. Fed negative capital / deferred asset: over $100 billion; close to $100–140 billion - Cabana says the Fed is effectively in negative equity territory and calls it a deferred asset. 10-year Treasury yield: a little over 4% - Used to illustrate that bond yields had round-tripped by late 2023. Nominal GDP growth in third quarter: about 5% annual rate - Cabana says stronger macro data was a bigger driver of higher rates than supply. Balance sheet shrinking since: mid-2022 - Hosts use this to argue the simple QT-to-equities story has been broken. Reserves level: about $3.4 trillion - Tracy notes reserves remain above pre-banking-crisis levels. Pre-mini banking crisis reserves: less than $3 trillion - Used to show reserves can move materially and thresholds are uncertain. BTFP termination timing: early to mid-March - Cabana says the emergency bank funding program is going away around that time. Potential low RRP threshold to slow QT: $200–250 billion - Cabana estimates the level at which the Fed may begin slowing QT, based on Fed commentary.

Pivotal Quotes: "This is the thing that gets people really riled up: the idea that stocks are up because of central bank legacy liquidity and once QT begins, it's all going to wash away and stocks are going to fall." — Tracy Alloway: Introduces the common market thesis about QT and risk assets. "We do think that this very technical facility that they have set up called the Overnight Reverse Repo Facility ... is really important because we believe that as long as there is excess cash ... there is clearly excess liquidity in the system." — Mark Cabana: Explains why the overnight RRP is central to judging when QT should slow. "The Fed is actually insolvent. They are running negative NIM and they have seen their capital essentially move into negative territory." — Mark Cabana: Describes the real financial cost of paying high rates on liabilities while earning lower returns on assets.

Implications: Markets should watch RRP usage, bank reserve demand, and money-market rates more than headlines about QT alone. If banks keep demanding more liquidity, QT may slow sooner than expected, potentially reducing funding-market stress and changing Treasury and rates dynamics.