The glut of spare cash in dollar funding markets is combining with inflation concerns to stoke debate among investors about just how soon the Federal Reserve might have to take its foot off the accelerator.
Bond traders are keenly attuned to the buildup of dollars in short-term interest-rate markets, an overabundance reflected in the amount of money sitting and earning absolutely nothing at the Fed's reverse repo facility.
For some, that's yet another sign that the so-called quantitative easing program ought to be dialed back from its current pace of $120 billion a month, although others say that the central bank facility is acting like it should, as a safety valve, and also point to the other factors fueling the oversupply.
Either way, the cash pile — and whether the usage of the Fed's facility resumes its upward trajectory after slipping on Friday — is set to be a key focus for traders in the coming week along with crucial U.S. jobs data, which may give clues about just how strong growth and inflation really are.
"Progress toward achieving the dual mandate should be the biggest factor" driving decisions about policy tightening, said Credit Suisse Group AG strategist Jonathan Cohn, referring to the Fed's twin goals on employment and consumer prices.
The drumbeat of policy makers making noises about when the Fed should debate tempering its asset purchases has been quickening, although officials have been careful to say that their views are premised on the economy continuing to power forward and the prospects for sustained inflation.
The strength of the upcoming labor market report is therefore set to be a major catalyst for bets about when both tapering and rate hikes might begin to take place, as will the evolution of funding markets.
The next central bank policy meeting will take place June 15-16, while there is talk of possible tapering signals coming out of the Kansas City Fed's annual gathering at Jackson Hole in August.
