Analysis: A “tsunami” of liquidity pushes rates further and further down. What will the Fed do?
Banks have too much money on hand – and they lack the places to put it.
Nowhere is this more evident than in the growing popularity of a Federal Reserve program that allows companies to put their money overnight at the US central bank in exchange for at best a small return. Payment nowadays: Zero percent.
But usage is reaching record highs as money market funds and other qualifying companies face what some analysts are calling a liquidity “tsunami”.
The banking system is swimming in nearly $ 4 trillion in reserves, in part thanks to the Fed’s asset purchases, lower Treasury bill issuance, and a rapid drawdown from government fund reserves at the same time. Fed. The general treasury account, or TGA, has fallen by nearly $ 1 trillion since last fall, reflected by rising bank reserves.
All of this liquidity is driving short-term rates down and raising expectations that the Fed will have to respond with a technical adjustment at its June 15-16 meeting, if not sooner, to keep its key rate from falling further.
The situation is also a headache for money market funds, which are absorbing much of the money and finding fewer options to invest it, a dynamic that the Fed is watching closely.
“They get money at the door and can’t find good places to invest it,” said Gennadiy Goldberg, senior US rates strategist for TD Securities.
TIME TO ACT?
Fed policymakers were briefed by staff on money market issues at their last meeting in April. A senior New York Fed official informed them that they may consider making a minor technical rate adjustment “in the next few months” if the downward pressure on overnight rates continues.
The effective federal funds rate – the central bank’s critical policy rate – slipped to 0.05% at the end of May before rising to 0.06%. It hovers near the bottom of the Fed’s target range of zero to 0.25%. The lowest ever reached daily is 0.04%.
The central bank’s response options include lifting the interest it pays on excess reserves, or IOER, which is currently 0.10% and is only available to banks. It could also raise the rate of the facility absorbing much of the additional liquidity: repurchase agreements, or reverse repurchase agreements, which are open to non-banks such as money market funds.
Together, the two are designed to form the “corridor” of the federal funds rate. The reverse repo rate – currently at zero – sets the floor by giving businesses a risk-free place to park some of their cash overnight. Usage hit a record $ 485.3 billion last week, down from almost nothing in March.
The growing popularity of reverse repurchase agreements may be a sign that the Fed has “injected too much liquidity into the market,” said Scott Skyrm, executive vice president of fixed income and reverse repurchase agreements at Curvature Securities. “It goes directly to the Fed.”
Policymakers have expanded access to the facility this year by relaxing eligibility rules and increasing the daily operations limit to $ 80 billion per user, from $ 30 billion.
But some analysts say the Fed may need to do more by raising the rate from zero, perhaps 2-3 basis points, or its more typical 5 basis point move. Any adjustment to the repo or IOER could take place at or before the June meeting, analysts said.
CUTTING OF FUNDS
Many banks, unwilling to accumulate more deposits, funnel part of the excess reserves into money market funds.
But with interest rates set to stay low for the foreseeable future, money market funds may struggle to find safe ways to invest this growing mass of money in order to avoid losses for investors. While they can waive fees, fund providers still have overhead costs to cover.
“At some point, those funds will also be called upon to be profitable,” said Steven Kelly, associate researcher in the Financial Stability Program at the Yale School of Management. Companies that “take money and invest it at zero return” may find it difficult to cover their expenses.
Some money market funds could eventually be forced to close to new investors or cut payments, he said.
The Fed could offer some relief to money market funds if it increases the rate it pays on reverse repurchase transactions, Kelly said. But that wouldn’t solve the long-term financial stability issues surrounding funds, which sometimes have to sell holdings in times of stress in order to meet redemption requests, he said.
The central bank and other regulators have singled out money market funds, which the Fed supported at the height of the pandemic and more than a decade earlier during the global financial crisis, as an area ripe for further reform.
“There is a structural problem and we know it,” Fed Chairman Jerome Powell said in an interview with CBS in April. “It is really time to tackle it decisively.”
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