May 25, 2022 | Premium Service | In this issue of The Institutional Risk Analyst, we start with a general market comment and, from that vantage point, then slide into the earnings reports from PennyMac Financial Services (PFSI) and United Wholesale Mortgage (UWMC).
The general comment is fairly simple to summarize: a massive surfeit of cash sloshing around the financial system and growing as stocks sell off, threatening to inundate the Fed with cash seeking a risk-free home. In theory interest rates are rising c/o the FOMC, but in fact risk-free collateral remains scare and rates seem more inclined to fall than to move higher.
At the end of last week, reverse repurchase agreements (RRPs) with the Fed of New York grew to over $2 trillion while the Treasury’s General Account (TGA) has soared to almost $1 trillion due to strong tax payments. As the TGA rises, bank reserves at the Fed fall 1:1. This illustrates why the Powell FOMC is going to find it very difficult to manage a reduction in the system open market account or SOMA. This fact will directly impact the financial performance of mortgage banks and all financials, especially issuers of securities.
“Treasury is still decreasing bill supply and that seems to be driving the market firmly into the arms of the RRP facility as the only place of refuge,” said Gennadiy Goldberg, a senior US interest rates strategist at TD Securities, Alexandra Harris of Bloomberg News reports. “The big implication is that with RRP usage remaining high, QT will drain reserves from the system rather quickly at the start of runoff.” It is managing the “runnoft,” to paraphrase the film "O Brother Where Art Thou," which is the task facing Jerome Powell.
Last week, as the TGA was rising on the back of stronger than expected tax payments, total reserves at the Fed fell by almost half a trillion dollars. “As a result, outstanding bank reserve balances dropped by $466 billion in the week ended April 20,” reports Harris, “the largest weekly decline on record.”
This outflow of bank reserves has the impact of forcing investors and banks back into the market for T-bills, which is already under downward rate pressure due to the Treasury’s large cash position and lack of new issuance. Observe that the 10-30 year complex in Treasury securities seems to want to rally in the worst way. Net, net, the dynamics in the market are actually forcing interest rates down even as the FOMC pretends to raise the cost of credit.