Latest / The Federal Reserve Podcast with Fexingo: Interest Rates, FOMC Meetings, and Monetary Policy / Why the Fed Is Watching the Treasury General Account
Transcript
- Lucas: So there's a number that's been quietly creeping back into the Fed's conversations, and it's not CPI or payrolls — it's the Treasury General Account. The TGA. That's the checking account the Treasury keeps at the Fed, and it's about to become the center of a very 2026 tug of war. Luna: Right, because Bessent is reportedly looking at tapping close to a trillion dollars in that account to fund bond buybacks. That's not small change. Lucas: Exactly. And the reason the Fed cares is that the TGA balance directly affects bank reserves. When the Treasury spends down that account, the money flows into the banking system — reserves go up, and that puts downward pressure on short-term rates like the effective fed funds rate. Lucas: Right now the effective fed funds rate is sitting at 3.63 percent, exactly where it's been for a while. But if the Treasury starts flooding the system with liquidity, the Fed might have to mop that up to keep rates in line with its target. Luna: So the Treasury's cash management becomes the Fed's monetary policy problem. That's a fun handoff. Lucas: It is. And it's not hypothetical. Remember, back in 2019, the TGA drawdown contributed to the repo market stress — the Fed had to intervene with temporary liquidity operations. Now they have the standing repo facility, but the dynamics are still there. Lucas: The interesting twist this time is that Bessent's buyback plan is explicitly aimed at calming the Treasury market. The ten-year yield is around 4.7 percent, and the long bond is even higher. There's a sense that the curve is steepening because investors are worried about fiscal deficits and inflation. Luna: And buybacks are supposed to signal demand and support prices. But the headlines say it's stirring inflation worries instead. What's the mechanism there? Lucas: Well, if the Treasury is using cash to buy back outstanding bonds, they're effectively injecting reserves into the system. That's stimulative. And if the market reads that as the Treasury accommodating a bigger deficit, or worse, as a form of debt monetization, you get inflation expectations ticking up. Lucas: You can see that in the ten-year breakeven inflation rate, which is at 2.34 percent. It hasn't moved much yet, but it's a level that the Fed is watching. They don't want breakevens breaking higher. Luna: So the Fed is in a bind. If they let reserves balloon, they risk losing control of the funds rate. If they drain reserves by selling assets, they risk tightening financial conditions that the Treasury is trying to ease. Lucas: Exactly. And that's why the Fed is likely to use tools like interest on reserve balances — currently at 3.65 percent — to keep the floor under rates. They can pay banks more to park those reserves, which keeps upward pressure on the funds rate. Luna: But that's effectively paying banks to do nothing. That's a cost the Treasury might not love, especially if they're already worried about the deficit. Lucas: True. But the Fed's mandate is price stability and maximum employment, not Treasury profits. And they'll defend that floor. The question is whether they have enough tools to manage the shift without drama. Lucas: And that brings up something I want to be honest about for a second, because we talk about the Fed's tools and balance sheet mechanics a lot. This show is only possible because a small group of listeners chips in monthly through buy me a coffee dot com slash fexingo. Luna: Yeah, that's what keeps us ad-free. No sponsors, no annoying mid-rolls. Just a few folks who like the deep dives. Lucas: Right. And it's not about perks or rewards — it's literally just funding the time we spend reading Fed statements and Treasury press releases so you don't have to. Luna: And if that sounds like something you'd support, the link is there. But back to the TGA — what's the actual history here? How did we get to a trillion-dollar balance? Lucas: Well, after the debt ceiling crisis in 2023, the Treasury rebuilt its cash buffer to avoid hitting the ceiling again. They issued a lot of T-bills, which drained reserves from the system. That's one reason the Fed had to keep paying interest on reserves at a high level. Lucas: Now, with the ceiling suspended until 2027, Bessent has room to maneuver. But using that cash to buy back long-dated bonds is a shift from the usual roll-off strategy. Luna: What would that do to the composition of the Treasury's liabilities? They'd be swapping T-bills for long bonds, essentially. Lucas: Sort of. If they buy back a long bond with cash, they're reducing the average maturity of the debt. That could actually steepen the curve if investors think the Treasury is less willing to issue long-term debt going forward. Luna: So the buyback might not even achieve the intended goal of flattening the curve. That's a bit of a paradox. Lucas: It's a real risk. And the market has been skeptical — the five-day move shows the S&P down a bit, but the long end is what's moving. The thirty-year yield is up to 5.23 percent. That's a big number for a market that's supposed to be calm. Lucas: So the Fed is watching this like a hawk, because if buybacks cause a steepening, that's a signal about fiscal dominance. And that's the one thing the Fed absolutely cannot tolerate. Luna: Fiscal dominance — that's when the central bank is essentially forced to keep rates low to accommodate government debt. That's the fear. Lucas: Exactly. And the Fed has been clear they won't go there. But the TGA drawdown could force their hand if it gets out of control. Luna: So what are the actual levers they can pull? They could do reverse repos, they could sell securities, they could raise the interest on reserves. Lucas: All those are on the table. But the problem is, they're all tightening in some form. And the Fed doesn't want to tighten when inflation is cooling — core PCE is at 130.3, up just a tick. They want to hold steady. Luna: So it's a delicate dance. They have to keep rates where they are, but they have to manage the liquidity injection. Lucas: That's the tightrope. And the effective fed funds rate is already right at the target. Any blip could push it below, and they'd have to scramble. Lucas: One thing that helps is that the Fed now has the standing repo facility, which provides a floor. But that's not a ceiling. If rates spike, they'd need something else. Luna: What about the reverse repo facility? That's been drained down as money market funds have moved into T-bills, right? Lucas: Right, the reverse repo balance has shrunk a lot. So that tool is less effective now. They'd rely more on the interest on reserves floor. Luna: So essentially, the Fed is hoping the Treasury doesn't draw down the TGA too fast. That's not a strategy, that's a prayer. Lucas: It's a hope backed by communication. But Bessent has been pretty clear he wants to calm the market, and he's willing to use the tools. The question is whether the Fed can keep up. Lucas: And there's a geopolitical overlay here too. The Canadian dollar is sliding as trade tensions escalate. That's another source of uncertainty that could spill into the dollar and inflation. Luna: So the Fed's job just gets harder. They have to watch the TGA, the curve, the geopolitical mess, and the data. Lucas: They do. But that's what they're built for. The real question is whether the market will give them the benefit of the doubt. Luna: Do you think they'll have to act before the next FOMC meeting? Like, an emergency action? Lucas: Probably not. But if the TGA drawdown starts pushing the funds rate below the range, they'd have to do something. The tools are there. It's just a matter of whether they need to use them. Luna: So keep an eye on the TGA balance. That's not something we usually say. Lucas: Exactly. And maybe the phrase 'Treasury General Account' will become the new 'two-year yield' for Fed watchers. We'll see.