Traders pile into Fed-linked futures amid short-term government funding fears

Traders are rushing into futures tied to the Fed’s overnight benchmark rate as fears grow that short-term funding could dry up before the quarter ￰0￱ Wednesday in New York, nearly 500,000 fed funds futures contracts for September were traded, breaking a record set in April 2023 when Trump’s tariff news hit ￰1￱ surge is happening while the effective fed funds rate quietly crept up to 4.09% on ￰2￱ single basis point move outside of a policy change was enough to rattle the futures market and raise red flags over overnight borrowing ￰3￱ are responding to a tightening repo market, where firms borrow cash overnight in exchange for Treasuries, as month-end and quarter-end always bring more pressure, with shrinking bank reserves and more Treasury bills flooding the ￰4￱ expect spike in repo rates before month-end Scrutiny on the rate has jumped since July.

That’s when Treasury started pumping out more bills, while the Fed kept slashing its balance ￰5￱ reserves are now ￰6￱ traders are warning this combo could lead to serious funding pressure at ￰7￱ slow their repo activity to clean up their books, and that usually pushes up borrowing costs. Everyone’s trying to front-run that ￰8￱ bulk of the action in September futures happened during Asia hours, with two blocks of 50,000 contracts ￰9￱ frenzy picked up again once ￰10￱ opened, especially as traders eyed the effective rate possibly hitting 4.10% before the month ￰11￱ almost 20 years, ￰12￱ markets were soaked in cheap ￰13￱ anymore. Now, rates on very short-term borrowing, used by banks and asset managers, are climbing.

That’s because the Treasury is rebuilding its cash pile while the Fed keeps tightening. Meanwhile, use of the Fed’s overnight reverse repo tool, a barometer for excess cash, just fell to its lowest in four years. “We are seeing a level shift in funding,” said Mark Cabana of Bank of America. “Money funds no longer have excess cash to deploy to the RRP.” As more T-bills get sold, investors move money out of repo and into those bills, which is dragging demand down while pushing rates up.

Interest-rate benchmarks tied to overnight repos are now sitting near the Fed’s interest on reserve balances rate, showing the ￰14￱ spread between repo and the fed funds rate has widened to about 11.5 basis points, the biggest gap since ￰15￱ spread was under 10 basis points for most of July and August, before the new wave of T-bills ￰16￱ weighs tools as collateral and reserves drop together Things may get worse ￰17￱ tax payments and new auctions are about to pull even more money from the system next ￰18￱ could upset the balance between cash and collateral — and banks already hold fewer reserves at the ￰19￱ balances have fallen to around $3.15 trillion, and Fed Governor Christopher Waller has warned that $2.7 trillion is probably the floor for what counts as “ample.” Meanwhile, rates tied to overnight financing keep climbing, which creates a headache for the Fed’s quantitative tightening strategy, the balance sheet reduction started in June 2022 and is supposed to finish by ￰20￱ it’s getting harder to manage with rates rising and reserves ￰21￱ Perli, who runs the Fed’s securities portfolio, said the central bank’s short-term interest rate tools will become even more critical in times like ￰22￱ more efficiently they work, the less damage markets ￰23￱ avoid another 2019-style repo panic, the Fed now uses the Standing Repo Facility (SRF), letting eligible firms borrow cash by pledging Treasuries or agency ￰24￱ facility charges a rate aligned with the top of the Fed’s target range, now at 4.5%.

It saw its biggest usage at the end of June since being made permanent in ￰25￱ it hasn’t been tested under real stress yet. JPMorgan’s team said the SRF could contain spikes in repo rates, reducing the need to cut QT ￰26￱ others aren’t so ￰27￱ is already looking shaky, and more volatility could force that debate to the ￰28￱ Fed officials, including Waller and Dallas Fed President Lorie Logan, admit funding stress is ￰29￱ they’re not pushing for an early end to ￰30￱ crypto news deserves attention - KEY Difference Wire puts you on 250+ top sites