A Setup for a Bigger SOFR Rate Crises ( US Repo Market )

(this version is a modified and updated report that was sent to "Clients" of  "ParaImbal LLC" on 12/15/2024)

By Asseged Major

​​Overnight Loan Market (Fed Funds Rate & SOFR Rate )

The Overnight Loan market is where a Lender provides a Loan to a Borrower overnight for 1 day, and the interest is paid back with principal back to the lender from the borrower. Very Short Term overnight or 1 day.

​The Fed Funds Rate is a Market between Banks that provide Loans to each other Overnight. These are mostly Overnight 1 Day Loans that pay interest. The SOFR Rate ( Secured Overnight Financing Rate ) is also an Overnight 1 Day Loan Market between Banks and other Financial Institutions. The difference is that the SOFR Rate Market collateral is provided by the Borrower to the Lender, where US Treasuries Bonds are provided as the collateral, and that is why the SOFR Rate market is considered a Secured Loan Market. For the Fed Funds Rate Market, it is considered an Unsecured Loan Market, because the Borrower does not have to provide Collateral to the Lender. All Overnight Loan Markets typically match the same interest rate return, meaning for example the interest rate in the Fed Funds Rate Market is going to be the same as the interest rate return in the SOFR Rate Market, if not there can be some arbitrage profit opportunity.

​Importance of SOFR Rate Market
The SOFR Rate is very important because it is considered outside of the Fed Funds Rate market the most important Overnight Loan market in the American Financial Lending System (Note: SOFR Rate replaced the Libor Rate, as Libor Rate was permanently ceased  ). In Addition, If Hedgers, Investors, Traders want to use Derivative Contracts to get exposure to the Fed Funds Rate, the most cost efficient and effective way is to buy or sell Futures Contract on the SOFR Rate. The Futures Markets for the SOFR Rate is a much more Traded and more Liquid Market than the Fed Funds Rate Futures Market, and this is why more Hedgers, Investors, Traders trade the SOFR Rate Futures contract rather than the Fed Funds Rate Futures contract.


Fed Funds Rate Impact on all Interest Rates
When the United States central bank “Federal Reserve” conducts interest rate policy, it targets the Fed Funds Rate market, meaning when the Federal Reserve is wanting to Raise Interest Rates or Lower Interest Rates in the Economy, they will do this by affecting the Fed Funds Rate Market through their policy tools which will directly have the effect of raising the Fed Funds Rate or Lowering the Fed Funds Rate. By raising or lowering the Fed Funds Rate, this has a spread effect of either raising or lowering all other Interest Rates in the US Economy, that is why it is very important.

SOFR Rate Crises 2019 (US Repo Crises)

In September of 2019, There was a SOFR Rate Crisis….., also termed the “ US Repo Rate crises ” . The SOFR Rate jumped in Huge divergence away from the Fed Funds Rate in just 1-2 days. From September 16 - 17, The SOFR Rate jumped from 2.43 % as high to 10 % in the intraday !,and then settled the next day to 5.25 % . While the Fed Funds Rate was at 2.25%. The Fed Funds Rate and SOFR Rate are typically the same or maybe just .01 off, for example on Sept 9 , 2019 both the Fed Funds Rate and SOFR Rate were at 2.12 % . Leading up to the days of the Huge Divergence on September 16th -17th, the crisis also caused the Fed Funds Rate to increase to 2.25 %, but a Huger Excess increase in the SOFR Rate. ( Look at Figure 1 & Figure 2 ) 

Fed Funds Rate & SOFR Rate (Median Rate for Transactions)
(Red Color = Fed Funds Rate, Yellow Color = SOFR Rate)
(Figure 1) 

SOFR Rate High Peak on Sept 17, 2019( Intra-Day )
(Figure 2)

( Source : Federal Reserve Bank of New York )

To put this in perspective of the SOFR Rate increase, an increase from 2.43 % to 5.25 % , is an increase of 282 Basis Points. This would be the equivalent of the Federal Reserve raising the interest rate of the Fed Funds Rate 12 Times ( 25 Basis Points increments = 0.25 % ), in 1 Day ! . During the day , the SOFR Rate high peak reached 10 %, this would be an equivalent of an increase of 757 Basis Points. This would be an equivalent of the Federal Reserve raising the interest rate of the Fed Funds Rate 30 Times ( 25 Basis Points increments = 0.25 % ) , in 1 Day ! . 

Federal Reserve intervenes in SOFR Rate Crises in September 2019 ( US Repo Crises ) 

​To bring the SOFR Rate back down and to the same levels as the Fed Funds Rate, the Federal Reserve intervened into the SOFR Rate market on September 17th , 2019. The Federal Reserve injected $ 75 Billion Dollars into the SOFR Rate Market. They provided $ 75 Billion Dollars as Loans in the SOFR Rate Market, which had the effect of driving down the SOFR Rate back to the level of Fed Funds Rate.


( Source : Federal Reserve )

​What was the Cause of the SOFR Rate Crises in 2019 ( US Repo Crises ) ?

​Main Assumption : Decrease in Supply of Cash Reserves in Banking System
​
By the Middle of September 2019, the amount of Cash Reserves in the Banking System reached multi-year lows at around $ 1.4 Trillion Dollars ( Look at Figure 3). During the 2 days of the SOFR Rate Repo Crises From September 16-17, there was a drainage of $ 100 Billion Dollars of Cash Reserves from the Banking System. Although a $ 100 Billion Reduction in Cash Reserves from the banking system in 2 days has occurred before, but it has not occurred during a time with a low level of Total Aggregate Cash Reserves ($ 1.4 Trillion ) in the system. The $ 100 Billion Reduction in the 2 days of the SOFR Rate Repo Crises, represented around a 7 % Reduction of Cash Reserves Levels ( $ 100 Billion / $ 1.4 Trillion ) in the Banking System. This Percentage Level of Cash Reserves being depleted in just 2 Days is a very large amount for the Banking System.  

Figure 3 - Total Bank Reserves in Banking System
​ (Leading to SOFR Rate Repo - 2019 Crises ) 

(Source : Federal Reserve Bank of St. Louis ) 

​​The main assumption of the cause was that there was a Drainage of Supply of Cash Reserves in the Banking System, which caused a Higher Demand for Cash Reserves than the available Supply of Cash Reserves left in the Banking System. In other words, Demand for Cash Reserves Exceeded the amount of Supply of Cash Reserves. If Banks have less supply of Cash Reserves, they will be more unwilling to lend in the Overnight Loan Market like the SOFR Rate Market. They would have less extra Cash Reserves to invest and lend in this market. This would cause a decrease in the number of Lenders that are willing to lend in the Overnight SOFR Rate Market, and this is what happened, as the number of Lenders Decreased, meaning the Supply of Lenders decreased in the SOFR Rate market,  the Interest Rate for the SOFR Rate increased by huge Large amounts. 




Factors that lead to a Reduction of the Supply of Cash Reserves :
But the assumption of the causes of the SOFR Rate crises are not 100 % concrete, in which Economists and Analysts attribute to a couple different factors that were happening more or less in combination causing a drain of Supply of Cash Reserves in the Banking System.


Below are Factors that lead to a Reduction of the Supply of Cash Reserves

• End of Quarter Reporting to clean up Bank Balance Sheets : at the end of the Quarter, banks like to clean up their balance sheet by removing any debt obligations or closing any related investment positions if they can to show more profitable strength on their balance sheet as they have to report to investors and markets at the end of the quarter and also for regulations reasons must have a certain minimum level of risk exposure. Banks and Financial entities at the end of the quarter are not uncommon for them to not lend as much in the SOFR Rate Market at the end of the quarter. Also, at the end of the quarter this is reflected in the SOFR Rate, as around this time is when it is most likely to differ from the Fed Funds Rate than any period during the year. At the end of the Quarter, SOFR Rate will usually just jump a little. But in September 2019 the Jump up in increase was excessively Huge.
  
  
  
• Quantitative Tightening : From October 2017 to August 2019, the Federal Reserve implemented Quantitative Tightening. From the 2008-2009 Financial Crises, new Policy Tools were implemented. From the crises they implemented Quantitative Easing, which was the Federal Reserve Purchasing of Long-Term Bonds such as Long-Term US Treasury Bond Securities and Mortgage-Backed Securities from the market, in turn this provided Cash Reserves to the Banking System and Economy. Quantitative Tightening is the opposite of this where the Federal Reserve will sell these Long-Term Bonds from their balance sheet that they were holding, and now sell them to the market, and in turn Cash Reserves will come out of the Banking System and Economy. Quantitative Tightening is done when the Federal Reserve wants to Raise Interest Rates, which will help decrease inflation.
  
  
  
• Corporate Tax Payment : the new Tax Rate decreases from the Trump Administration started to take effect starting in January 2018. Corporate Tax Rate was decreased to 21 % . This caused a lot of Large Corporations that used Loopholes to park their Cash Holdings in overseas locations to now bring back their Cash Holdings back to the United States because of the Lower Corporate Tax Rate. This caused a Large increase in Revenue for the US Government into the US Treasury, as Large Tax Payments were being made from Corporations. As any Cash is sent to the US Government’s US Treasury , this Cash is not sitting in the Banking System, which causes Less Cash Reserves in the American Banking System. Before as the Corporations held their Cash Holdings in overseas, they would use that cash to purchase US Treasury Government Bonds, but since now that portion of Cash is not used to purchase US Treasuries Bonds, this means there would be other buyers that would have to replace those Bond Sales, which also would have effect of decreasing Cash Reserves in the banking system to be lent for the overnight SOFR loan market.
  
  
  
• US Banks & Brokers (Primary Dealers) increase of US Treasury Holdings : Primary Dealers are approved firms by the Government to be Counter-Parties and Market Makers for Government Securities like US Treasuries Bonds (Debt). Primary Dealers are made up of Large Capitalized Banks and Broker-Dealers. Right before the SOFR Rate Repo crises in September 2019, Primary Dealers reached an all time high in holding US Treasuries Bonds on there balance sheet at over $ 200 Billion Dollars (Look at Figure 4) .

(Figure 4 ) US Primary Dealer - US Treasuries Net Position
​ ( 2015 - 2019 )

( Source : Federal Reserve Bank of New York )

​They became a huge buyer of US Treasuries Debt than normally. How would this effect the Overnight SOFR Rate ? this would mean Banks and Broker-Dealers would allocate more Cash to buy US Treasury Bonds, this means they would allocate less cash to lend in the Overnight SOFR Rate Market, meaning they are decreasing there participation in the SOFR Rate Market, which means there is less supply of lenders in the SOFR Rate Market,  which has the affect of increasing the SOFR Interest Rate. What Caused the US Primary Dealers to buy so much US Treasuries and have a large Net Position  ? Well by there nature, since the Primary Dealers are Market Makers for US Treasuries when they get issued in the Primary Market, they have the legal obligation in being required to buy the US Treasuries in the Primary Market from the US Government and Resell them regardless of Market Conditions. There were a couple of factors that aided in leading less buyers from the general market, in which may caused the Primary Dealers to step in and buy more of the Portion of US Treasuries than usual.

• • (1) Increasing National Debt : There was an increase in the US National Debt. The Trump Tax Cuts that went effect in 2018, would mean less government revenue coming in, in which more National Debt would be increased to continue the Spending Amounts. In order to increase the National Debt, this means New US Treasuries would have to be issued and sold, which causes more of the Cash from the Primary Dealers to be used to buy US Treasuries, and also other Market Investors would buy the US Treasuries as well. Any purchase of newly issued US Treasury Bonds is cash that is being sent to the Government's US Treasury, and not being inserted into the Banking System, which has a net effect of decreasing Cash Reserves in the Banking System, which means less cash reserves to be lent out to the Overnight SOFR Loan Market.
    
  • (2)  Increasing US 10 Year Treasury Bond Yield :
    If Investors fear that Inflation is increasing or being a problem in the United States, or if Interest Rates rises, this will cause the 10 Year Treasury Bond Yield to rise. Effecting the increase in the Yield were In 2018 the Federal Reserves was raising the Fed Funds Rate, and also there was from the Trump Administration effects of Trade Tariffs with the US Economy of the increasing costs of imported priced goods like from China, feared investors of not to buy US 10 Year Treasury Bonds, causing the US 10 Treasury Bond Yield to increase. Foreign Investors began to decrease their Purchases of US 10 Year Treasury Bonds, therefore needing other buyers such as US Primary Dealers to step up and buy US 10 Year Treasuries, which had the net effect of less cash reserves in the Banking System to be lent to the Overnight SOFR Loan Market.
    
  • (3) Large Settlement of US Treasuries Long Term Debt on Sept.16th : In Addition there was also $ 54 Billion Dollars of US Treasury Debt that was being settled on Sept.16th, the day before the start of the crises. Long Term Debt is matured and settled , as new debt gets issued to replace maturing debt, the Primary-Dealers have to buy more New Issued US Treasuries, which further decreases the cash on hand, and which further decreases cash reserves in the banking system.
    
  • (4) Primary Dealer using SOFR (Repo) Market to purchase US Treasuries : Primary Dealers were borrowing cash in the SOFR Rate Market to purchase US Treasuries. This further increased the Demand for Borrowing in the SOFR Rate Market, with the other already depleted Supply of Lenders in the SOFR Rate Market, which Drove Up the SOFR Rate , as Demand of Borrowers exceed the number of Supply of Lenders in the SOFR Market.  
    
    
    
  
  
  
• Bank Regulation & Minimum Reserves Requirements : During the SOFR Rate Crises, Interest Rates were so High, that it would be very profitable for a Lender to lend at those rates, which would ultimately lead to a lot of lenders jump into the market to get that advantageous profit, which would ultimately lead to the rates coming back down to the normal level. But that did not happen. The reason why some Banks did not do that is that some had stated that there are Regulation requirements that they have to follow about how much reserves to keep on hand, and also there are different accepted minimum reserve levels that each Bank has created for themselves based on their preference, some banks set their reserve levels higher, some set it lower, it’s based on each created procedure and rules of each bank. For these reasons, Some Banks had well enough Cash Reserves to enter the Overnight SOFR Loan Market, but for keeping minimum reserve levels, they did not enter the market. 
  

( Source : Financial Times “repo crises brewing”, Financial Times “Repo: How Plumbing got blocked“, Yardeni Research , Fed Reserve “What Happened in the Money Markets in 2019” ) 

Current Similar Signs of SOFR Rate Crises in 2025
​and Beyond ( US Repo Crises ) 

Current Increase Spikes in SOFR Rate  

The SOFR Rate experienced a much more than usual Jump in increase in the First Week of October 2024. A large enough jump that it has dealers in the SOFR Rate market worried that another potential SOFR Crises can emerge again. In addition, this Large Spike Increase in the SOFR Rate was after Sept 18th, after the Federal Reserve decision to apply to  decrease by 2 Cuts on the Fed Funds Interest Rate, to decrease the Fed Funds Rate by 50 basis points. From Sept 26 to October 1, the Fed Funds Rate remained at 4.83 %, but the SOFR Rate jumped from 4.83 % to 5.05%, a 22 Basis Point increase in 4 business Days. The Highest SOFR Rate Spike up since the SOFR Rate crises in 2019. This increase in the SOFR Rate is equivalent to erasing 1 Cut from the Federal Reserve decision to lower the Fed Funds Rate, itis reversing nearly 1 cut which is equivalent to 25 Basis Points (0.25 %), SOFR Rate increased by 22 Basis Points (0.22 %) that day. 3 days later on October 4th,the SOFR Rate decreased back down to the level of 4.83 %, the same as the Fed Funds Rate. Look at figure 5 below. 

Fed Funds Rate & SOFR Rates (Median Rate for Transactions)
(Red Color = Fed Funds Rate, Yellow Color = SOFR Rate)
​ (Figure 5) 

( Source : Federal Reserve Bank of New York )

Again in December, the SOFR Rate jumped over 20 Basis Points Higher than the Fed Funds Rate, SOFR Rate at 4.53 % and Fed Funds at 4.33 % . This happened again after the Federal Reserve Interest Rate cut which was on December 18th, which lowered the Fed Funds Rate to 4.33 % . The SOFR Rate jumped in total 23 Basis Points from 4.30 % on December 19th to reaching 4.53 % on December 26th. Again this increase in the SOFR Rate of over 20 Basis Points is equivalent to reversing the Interest Rate Cut that the Federal Reserve did on December 18th. ( Look at Figure 6 )

Fed Funds Rate & SOFR Rates (Median Rate for Transactions)
(Red Color = Fed Funds Rate, Yellow Color = SOFR Rate)
(Figure 6) 

( Source : Federal Reserve Bank of New York )

Throughout the remaining of December the SOFR Rate remained a significant large amount higher than the Fed Funds Rate, but by January the SOFR Rate came back down to the same levels of the Fed Funds Rate.( Look at Figure 7 Below ) 

Fed Funds Rate & SOFR Rate (Median Rate for Transactions)
(Red Color = Fed Funds Rate, Yellow Color = SOFR Rate)
( Figure 7 ) 

( Source : Federal Reserve Bank of New York )

Quantitative Tightening

The Federal Reserve has been implementing Quantitative Tightening since June 2022, and is continuing todo so right now. Due to the Monetary Stimulus that was done after Covid, which increased the huge amount of Money Supply and Cash Reserves into the Banking System through Quantitative Easing. Due to the huge inflation increase since then, in order to reduce inflation in addition to having raised the Fed Funds Rate, they are applying Quantitative Tightening, which in effect decreased the amount of Cash Reserves in the Banking System. Since the beginning Quantitative Tightening near of June 2022, the Federal Reserve has reduced its Balance Sheet by around $ 2 Trillion dollars, meaning they have sold off nearly $ 2 Trillion Dollars of its holdings of Long-Term Bonds into the market ( US Treasuries Bonds, Mortgage-Backed Securities ). During the Covid pandemic they also purchased some short-term bonds for their holdings, so they sold off a portion of short-term bonds as well. While they have been conducting Quantitative Tightening since June 2022, at the same time starting in September 2024 they began to Cut and lower the Fed Funds Rate. These two actions are in opposite Effects of each other, Quantitative Tightening purpose is to Reduce Cash Reserves in the Banking System and Raise Interest Rates in the Economy, but Cutting and lowering the Fed Funds Rate purpose is to Increases Cash Reserves in the Banking System and Lowering Interest Rates in the Economy. There will be a point when the Federal Reserve decides to stop Quantitative Tightening, but as of right now they are continuing it, and what is unique about this current round Quantitative Tightening is that they are doing it when they are lowering the Fed Funds Rate.

(Data Source : Federal Reserve ) ​​

​Banking System Cash Reserves are not decreasing with Quantitative Tightening

Since the Federal Reserve began Quantitative Tightening in June 2022, and up to presently of the latest data of January 2025, Total Bank cash reserves have not changed roughly at all. In June 2022,Total Bank cash reserves were $ 3.22 Trillion , in January 2025, Total Bank cash reserves were $ 3.25 Trillion, Look at Figure 8 below .

Total Bank Reserves in US Banking System
( Figure 8 ) 

​This is unlike the Quantitative Tightening that was leading right before the SOFR Rate Crises of 2019, where the Quantitative Tightening lead to a substantial amount of decreased Bank Reserves. The Quantitative Tightening that led before the 2019 Crises decreased the Bank Reserves at a Faster pace.  Researchers at the Federal Reserve Bank of St. Louis issued a research analysis of some of the reasons why the actual Bank Cash Reserves did not change since the start of Quantitative Tightening began in June 2022. A prime reason is because during mostly through this time period , the Yield for Long Term Bonds like the US 10 Year Treasury Bond are lower than the Yields for Short Term Bonds and short-term interest accounts. In other words, an Inverted Yield Curve. Banks have the option to deposit their reserves in the IORB Rate (Interest On Reserve Balance) account, which is a Deposit Account at the Federal Reserve, where the Federal Reserve will pay them an interest rate overnight, if they deposit their reserves in the Account. If the Yield Curve is inverted, meaning the interest rate return on Short Term Bonds and Short Term Interest Accounts like the IORB or Fed Funds Rate is higher than the interest rate on Long Term Bonds like the US 10 Year Treasury Bond, than the Banks have a more incentive to not to purchase into US 10 Year Treasury Bonds, and rather use their reserves to deposit into the Overnight Interest Rate deposit account of the IORB Rate or lend in the Overnight Loan market like the Fed Funds Rate. For example, in 4th Quarter of 2023 the IORB Rate was 5.40 %, versus the US 10 Year Treasury Bond Yield at 4.45 %. Currently the IORB Rate is 4.40 %, and the US 10 Year Treasury Bond Yield is at 4.26 % as of Feb 26 . It is more advantageous for the Bank to deposit there reserves and get a higher return with the IORB Rate, rather than purchase US 10 Year Treasury Bonds. As a result, this has increased reserves in the banking system, while offsetting the depletion of the reserves from Quantitative Tightening.

(Source : FRED , Federal Reserve Bank of St. Louis , Federal Reserve , TradingEconomics ) 

Primary Dealers at All Time High in US Treasuries Net Positions  

Similarly as experienced in 2019 when SOFR Repo Crises happened, currently Primary Dealers have an all time high in holding US Treasuries Net Positions. Data as reflected as of February 5, 2025 shows Primary Dealers have a US Treasuries Net Position of $ 370 Billion, this exceeds the previous all time high that was reached in 2019 at around $ 200 Billion ( Look at Figure 9 ).  

( Figure 9 ) US Primary Dealer - US Treasuries Net Position
( 2022 - 2025 )

(Source : Federal Reserve Bank of New York)

Risk Factors in SOFR Rate Crises appearing in 2025 and Beyond

​Many of the same conditions leading up to the SOFR Rate Repo Crises in 2019, are currently here but even more stronger. There was a unique event of Corporate Tax payment that was due on Sept.16th, that flushed out Cash from the banking system, but all the other factors today are showing……..Quantitative Tightening, Primary Dealers all time high of net positions of US Treasuries, large end of quarter spikes in SOFR Rates, and large settlement of US Treasuries debt due in 2025.


An Over-Arching difference between now and when the SOFR Rate Repo Crises happened in 2019 is that back then inflation was low, and the risks of future higher inflation was very low. Post Covid Pandemic, today, Inflation is much higher, and the risks for continuing higher inflation is much stronger. Historically, Interest Rates rise higher in a inflation environment versus a non-inflationary environment. By this very fact, its more likely that the SOFR Rate will increase than compared before. The setup of the current economic environment further makes it much more likely that a SOFR Rate Crises is much more able to happen today than compared to the previous one, and in higher Magnitude.


Because of the current Economic Environment, the risks of the US 10 Year Treasury Yield of Increasing is much higher than what it was in the previous SOFR Rate Crises. A Higher US 10 Year Treasury Yield may drive the typical buyers of US Treasuries away, causing the primary dealers to increase there already all time record high US Treasuries net positions, thus flushing out Banking System Cash Reserves.

Federal Reserve - Policy Error (Credibility Risk) : Since the Federal Reserve began the first Fed Funds interest rate cuts in September through December, for a total of 4 interest rate cuts, or 100 basis points (1 % ) , the long term interest rates in the Economy has went upwards, in effect this is the opposite of what is suppose to happen. As you can see in figure below. The 10 Year US Treasury Yield increased from 3.65 % the day before the first Interest Rate Cuts in September 18th, to currently 4.26 % as of Feb.26 ( Look at Figure 10 ) . There were no interest rat cuts needed, as inflation has increased and far from the Federal Reserve Inflation of 2.0 % Target, as both the inflation rates are not near, as the Core CPI is currently 3.3 % for January 2025, and latest Core PCE Inflation Rate at 2.8 % for December 2024. Even through the time of Higher Interest Rates, the Money Supply in the Economy has been increasing, any effects of lower short term interest even if temporary would spill over in flows to riskier assets try to gain higher returns, further adding fuel to the Money Supply in the Economy, driving Inflation Higher. There is a real threat of Credibility Risk of the Federal Reserve from the Financial Markets. By cutting interest rates when it did not need to, if Inflation continues to increase higher, the market will feel low confidence in the Federal Reserve in controlling Inflation, which may cause less buyers of the 10 Year Treasury Bond, causing the 10 Year Treasury Yield to increase significantly. It could cause exasperated increases in interest rate markets in very short span of time, causing large increase spikes in the SOFR Rate and Fed Funds Rate, causing large reductions in Bank Cash Reserves in the banking system.

US 10 Year Treasury Bond Yield ( Figure 10 ) ​

( Source : TradingEconomics ) 

Trump - Trade Tariffs - Impact : The Trump Administration already has implemented or plan to implement Trade Tariffs. The huge difference between now and during Trump Administration first term is the High Level of Tariffs in this second current term that they plan to implement. The Tariffs effects in the second term if implemented is way more Impactful than first term, as they wider in scope of number of countries and considered to be possibly universal meaning all countries, and at high rates. This is what was underestimated by financial markets when Trump won the election in November, and Markets went higher, is that even if a quarter of what is proposed materializes for the Tariffs of what Trump campaigned on the election, it would be extremely detrimental to the US Economy. It was very misleading for Markets to act so positively after he won the election, really acting as ignoring the fact of any tariffs would be implemented at all. As of Right now, there is a 10 % Tariff on China for packages over $ 800 dollars. Canada and Mexico Universal Tariffs meaning all goods are set to start March 4th, and Universal Tariffs of 25 % on Aluminum and Steel on all countries are set to start March 12. Now of course until those dates happen, before then there could be negotiations between the US and the countries in that the Tariffs may not happen and be cancelled or they maybe a compromise such as reduction of the Tariff Rate or amount of goods. But as the Trump Administration is planning to collect revenue from tariffs and use it as a key revenue generator and the belief of Tariff Policy being the main Hallmark of the Trump presidency, Tariffs of strong scope are likely to be implemented. Implementing Tariffs right now in the US Economy could not come at a Worse Time, as Inflation has remained sticky and been increasing. Conventional Economics state that Tariffs are inflationary, so any implementation will increases of goods and services in the economy. A Tariff is a tax to the domestic producer for buying imports, in which the producer will pass it on to the consumer by increasing the price of the good. As a higher tax rate will increase the price of the good, by its nature a tariff is inflationary. As Tariffs get implemented in the economy, the market Inflation Expectations will increase driving the US 10 Year Treasury Yield higher and increasing interest rates. At the same time, since a Tariff is a Tax, the Domestic Producer paying the tax on the import will have the affect of cash reserves being sent out from the Banking System into the Government Treasury Account, thus reducing available Supply of Bank Cash Reserves in the banking system.     

​The Psychological Level of 5 % on US Ten Year Treasury Yield and impact on Banks Cash Reserves : If the US 10 Year Treasury Yield reaches and sustains above 5 %, this can cause multiple changes in markets. For one, it is a market level that psychologically that has not been reached and sustained above for quite some time, the last was in June 2007. Throughout the post covid pandemic Inflation Peak of 9 % in June 2022 and afterwards, the US 10 Year Treasury Yield did not reach 5 %, except in October 2023 where it reached 5.02 %, but than quickly retraced below afterwards. A US Economy and Financial Markets that have been so used to low to 0 % percent interest rates for 14-15 years since the Housing Bubble & Financial Crises in 2008 there sentiment is with shock when hearing the possibility of 5 % interest rates and higher, although historically 5 % is quite the norm in the US Economy.

If the 10 Year Treasury were at 5 % Yield and Higher it would make it more expensive for long term loans in the economy like Mortgages for borrowers as the interest will be higher, but a 5 % and Higher Yield on the 10 Year Treasury may directly impact Short Term Overnight Rates like the Fed Funds Rate, IORB Rate , SOFR Rate. For Example the IORB Rate is currently 4.40 %, and Fed Funds Rate is 4.33 %, and the SOFR Rate is at 4.33 % . If the US 10 Year Treasury Yield is lets say at 5.50 %….., why would a Bank or Financial Institution lend at the Fed Funds Rate, SOFR Rate, or deposit at IORB Rate, when it can get a much Higher Return in Buying a US 10 Year Treasury Bond with a Interest Rate Yield at 5.50 %……? The answer is they would likely not lend in the overnight rate markets or deposit , and they would likely buy the US 10 Year Treasury Bond for the Higher Investment Return. This type of scenario can have some very big market spillovers in overnight rate markets, especially if the US 10 Year Yield increases by very large moves and much higher than a 5 % Yield. It could cause a reduction of Bank Cash Reserves in the banking system.

If the US 10 Year Treasury Yield reaches a certain level (e.g., 5 %, 6 %, 7 %) and is higher than IORB Rate or Overnight Loan Market Rate (Fed Funds Rate or SOFR Rate ) by a very significant amount, banks and other financial institutions instead of depositing their reserves at the IORB Rate with the account at the Federal Reserve, or lending in the Overnight Fed Funds Market or SOFR Rate Market, will take their reserves and purchase US 10 Year Treasury Bonds, because the Interest Rate is much higher than the IORB Rate or Fed Funds and SOFR Rate, which would result in a reduction of Cash Reserves in the Banking System, which would mean less Cash Reserves to be lent out in the overnight SOFR Rate Market, causing the SOFR Rate to potentially sky rocket upwards like it did the previous SOFR Rate Market crises.

(Source : Federal Reserve, TradingEconomics, Federal Reserve Bank of New York Markets Data Hub , Reuters , Bloomberg    )

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