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Usage of a Federal Reserve facility that allows investors to park their cash overnight has dropped to its lowest level in a year, as US money market funds instead add to their holdings of government debt.
Investors on Thursday stashed $1.93tn in the Fed’s overnight reverse repo facility (RRP), where cash is stored risk-free for a generous return. That is the lowest amount in a year, down by more than $200bn this month.
US government money market mutual funds, which manage $4.5tn, aim to offer clients an ultra-safe and ultra-liquid product that delivers relatively stable returns. They typically place most of their cash in short-term Treasury bills, but volatility in those yields in the last two years — as the Fed has raised interest rates aggressively — has pushed money funds into RRP, which delivers risk-free, predictable returns. A shortage of bills for the past few years has also driven demand.
The RRP facility was established permanently in 2014, and is designed to suck up excess cash in the financial system. Money funds, the biggest users of the facility, largely avoided using it until 2021. Ballooning usage since then has helped drain some liquidity from the banking system, which has become a concern this year as banks have struggled to hold on to deposits.
Regulators and analysts have long expected usage of RRP to sink, especially this month as the government has flooded the market with Treasury bills.
While RRP levels have finally begun to fall, analysts say they expected that to happen more quickly than it has given a burst of short-term debt issuance by the US government, which is replenishing coffers that were depleted during the debt ceiling fight. The reluctance of money market funds to plough headfirst back into Treasury bills betrays a lingering unease about the direction of US interest rates as inflation remains stubbornly high.
“We have been surprised that more money hasn’t left the reverse repo facility,” said Mark Cabana, head of US rates strategy at Bank of America. That slower than expected drop, Cabana said, is because yields on Treasury bills have not risen enough to compensate money funds for the risk of holding debt that would lose value if the Fed raises interest rates again.
Cabana expects the Treasury department to issue roughly $1tn worth of bills from the start of June to the end of August. Of the $340bn in bills issued since the debt ceiling agreement was reached on June 2, RRP has come down by just over $200bn, far less than Cabana and his team were expecting.
Brandon Swensen, a portfolio manager at BlueBay Fixed Income, said the group’s funds have a short average maturity, implying they have not been buying many of these new Treasury bills, and they are expecting to stay focused on short maturities. “We really don’t want to be putting money to work when we’re not getting paid for the hikes the Fed still has yet to do.”
In moments when the Fed is raising interest rates, Treasury bills currently on the market tend to reflect the expected rate increases through higher yields. Yields on Treasury bills have moved a little higher this month since the central bank indicated at June’s rate-setting meeting that it expects to raise interest rates twice more this year — but not yet enough to fully reflect the risks of more rate increases.
The RRP currently pays an annualised 5.05 per cent return, while the comparable rate on Treasuries, which carry more risk, is roughly 5.2 per cent.
With money funds only buying some of the Treasury bills on offer, that has left the remainder to be sucked up by other investors such as companies, state and local governments, and individuals. If that trend continues, it could add to the ongoing drain on bank deposits, which have been falling since the collapse of several regional lenders in the US earlier this year.
“Money funds have been buying more Treasury bills, but they’ve been more than happy for individuals and other investors to take down a bigger share than they normally would,” said Peter Crane, the head of Crane Data, which tracks the money market fund industry.
Cash that flows into the government’s coffers to pay for new T-bills in effect leaves the banking system. Money stashed in the RRP similarly acts as a drain on overall levels of liquidity in the system. That means a burst of borrowing without a corresponding decline in use of the Fed facility could place further strain on the banking system, analysts say.
“If money funds are using RRP, it suggests someone else is going to have to buy the bills, so bank reserves are going to have to fall more,” said Tom Simons, a money market economist at Jefferies.
Additional reporting by Harriet Clarfelt
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