Fed Officially Announces March Expiration of BTFP: Does Drying Up Liquidity Signal an Imminent QE?

The Federal Reserve officially announced on Wednesday that the funding support created for banks last year, the Bank Term Funding Program (BTFP), in response to the potential financial crisis caused by the collapse of Silicon Valley Bank, will be terminated as planned in March. Banks can continue to get new loans until March 11 under this program, but the interest rate won't be lower than the reserve rate on the day of the loan.

The decision was primarily driven by the increased arbitrage opportunities resulting from the decline in BTFP borrowing costs, which has also led to a significant increase in BTFP usage in recent times.

Against the backdrop of deepening expectations of interest rate cuts, the 1-year Overnight Indexed Swap (OIS) rate has decreased, resulting in a reduction in BTFP borrowing costs. As a result, banks can deposit BTFP loans into their Federal Reserve accounts and earn risk-free interest rate differentials.

According to data from the Fed, outstanding loans as of January 17 totaled $161.5 billion. Furthermore, the average weekly increase over the past six weeks amounted to nearly $5.6 billion, representing the largest weekly surge since the beginning of May.

Deutsche Bank AG strategist Steven Zeng said, "It shouldn't come as a surprise to anyone but the announcement coming sooner than expected says to me that there is really limited tolerance from the Fed of banks taking advantage of any facility designed for emergency backstops."

Crisis in US small and midsize banks forced the Fed to "expand its balance sheet" and provided bank Liquidity through BTFP. As BTFP comes to an end in March, a significant amount of liquidity will be withdrawn. According to Eugene Leow, a senior rates strategist from DBS, “Assuming that the program ends, some $70-80bn would probably mature within a month. Stack another $80bn (QT run rate) and roughly $150bn of liquidity will be removed in March.”

The overall balance sheet size of the Fed has declined from a peak of just shy of $9 trillion in mid-2022 to its current size of $7.7 trillion. As liquidity pressure mounts, ending the balance sheet runoff sooner rather than later could alleviate some of the market's concerns and prevent a repeat of the 2019 “money crunch” crisis.

Lorie Logan, president and chief executive officer of the Dallas Fed, said in a speech that "Given the rapid decline of the ON RRP, I think it's appropriate to consider the parameters that will guide a decision to slow the runoff of our assets. In my view, we should slow the pace of runoff as ON RRP balances approach a low level."

In order to avoid a liquidity crisis, investors are eager for the Fed to take preemptive action to lower interest rates. After the Fed's decision to terminate the BTFP, the expectations for a rate cut have slightly intensified. According to the latest data, the probability of at least 25bp rate cut in May has increased by 4.9bp to 87.18% from the previous day's 82.29%.

Over the past one month, hard economic data has supported the thesis of "soft landing", with December retail sales showing consumer spending finished 2023 in a better position than many economists worried. Building permits rose by more than expected in December, too.

The labor market has demonstrated its resilience, as evidenced by the latest jobless claims data which showed the lowest level since September 2022.

The latest S&P global flash US composite PMI came in at 52.3 in January, up from 50.9 in December and better than expectation by economists, again underscoring how the soft landing scenario could be within reach. Chris Williamson, the chief business economist at S&P Global Market Intelligence, said in the release：