A growing chorus of investors is urging the Federal Reserve to act to prevent negative rates taking hold in parts of the US financial markets, as a wall of cash drives down yields on short-term debt and threatens to overwhelm the $4tn money market fund industry.
The Fed is set to discuss the intensifying pressure in US money markets at its meeting this week, after record sums of cash were parked at the central bank overnight on Monday at a zero interest rate.
After more than a year of large-scale economic stimulus from the Fed and the US government, investors say, too much money is seeking a home in short-dated Treasuries and other securities. In some cases in recent weeks, that has pushed the yield on some debt into negative territory.
If pressures continue, the situation could become a “matter of the monetary system functioning”, said Gennadiy Goldberg, a rates strategist at TD Securities. “If you do get enough cash that simply cannot find a home, the downward pressure on rates will intensify even more.”
The issue is particularly acute because negative rates would upend the economics of money market funds. These vehicles, which invest in short-term Treasuries and other debt, are used by businesses and individuals as an alternative to keeping money in a bank. MMFs also play a crucial role in the repo market, advancing short-term funding to a wide variety of other investors.
Assets in so-called government money market funds, whose investments are limited to Treasuries, jumped above $4tn for the first time last month, meaning more money than ever is chasing short-term debt just as the US Treasury is scaling back its issuance of such bills.
“It is a bit Dickensian at the moment: the best of times in terms of assets under management, the worst of times for trying to invest that money,” said Thomas Callahan, head of global cash management at BlackRock. “The Fed has the tools to alleviate the pressure.”
The dearth of suitable investments has compelled money market funds to place more assets with an overnight Fed facility called the reverse repurchase programme, which pays no interest. Use of the facility climbed to a record $584bn on Monday, and strategists at JPMorgan estimated it could soon hit $750bn.
Some market participants want the central bank to jolt short-term rates higher by agreeing to pay more than zero on the RRP. It could also raise the rate it pays banks on excess reserves that they hold at the Fed.
“We think a tweak might make sense to minimise potential financial stability risks that might arise if money market funds [and banks] are no longer as willing to take in cash and to ensure RRP remains a strong floor for money market rates,” strategists at JPMorgan wrote in a recent note.
Large asset managers with hefty money market fund franchises have been forced to defer fees, since these would wipe out returns and render their funds uneconomical for clients. Some have also warned of potential closures while they wait for some relief from the Fed.
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“There is an expectation in the market that the June meeting will result in an adjustment of rates,” said Kevin Gaffney, chief investment officer of money markets at Fidelity. The firm manages $900bn in money market assets and accounts for nearly one-fifth of the US money market fund industry.
Others are not so sure the Fed will act immediately, even if chair Jay Powell recognises the pressures during his post-meeting press conference on Wednesday. The federal government’s debt ceiling, suspended for the past two years, is due to come back into force on August 1, meaning a congressional debt deal could be near that would encourage the Treasury to issue more short-term bills.
The Fed’s main policy rate — the federal funds rate, which it has promised to hold in a range of zero to 0.25 per cent — has steadied at 0.06 per cent, having dipped to 0.05 per cent briefly earlier this year.
“The market is still functioning,” said BlackRock’s Callahan, “but this is helped by half a trillion dollars sitting in the RRP earning zero interest.”