Wall Street braces for liquidity stress in money markets

A surge in US Treasury bill issuance in recent months has reduced liquidity in the financial sector, stoking investor concerns that funding markets could face a September squeeze.

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That could create ripple effects through markets by reducing demand for assets like stocks and corporate bonds, and pushing some investors to set cash on the side in anticipation of volatility.

Some say there is a mild risk of a repeat of 2019 when a liquidity shortage caused a spike in short-term borrowing rates until the Federal Reserve intervened in overnight markets to alleviate the crunch.

"There is some concern that we could have a repeat of September 2019 at quarter-end due to technicals, corporate tax days, and coupon settlements," said Teresa Ho, head of short duration strategy at JPMorgan in New York.

In September 2019, overnight funding costs in the repurchase (repo) market spiked due to a large drop in bank reserves amid large corporate tax payments and payments for Treasury debt, forcing the Fed to inject liquidity in repo markets.

Some measures of liquidity are already signalling stress ahead, such as a higher cost of borrowing cash overnight collateralised by Treasuries. Still, money market conditions are different. The Fed has launched the Standing Repo Facility (SRF) — that could be tapped by banks for emergency liquidity, and bank reserves - the biggest component of overall financial sector liquidity - are much higher at $3.2 trillion than in 2019.

However, the Fed has been shrinking its bond holdings for over three years, drawing attention to liquidity. At the same time, rapid issuance of Treasury bills by the government after the debt ceiling was raised in July, has prompted traders to anticipate potential stress.