A facility that allows money market funds and banks to park their cash at the Federal Reserve was tapped in record size on Thursday, underlining the dearth of options for investors given the collapse in yields for the ultra-safe, short-term securities that they typically invest in.
Some 50 participants parked $485.3bn at the US central bank through its reverse repurchase programme (RRP), according to data from the New York branch of the Fed. The figure eclipsed the record $474.6bn drained from the system on New Year’s Eve in 2015 and marked an uptick from the more than $400bn placed there overnight on both Tuesday and Wednesday this week.
Demand has soared for the facility in recent months as yields on Treasury bills — which mature in one year or less — and the rate at which investors swap high-quality collateral such as Treasuries for cash in the repo market have slid below zero. The RRP pays 0 per cent interest on the cash deposited overnight.
“The surge in demand for the Fed’s RRP operations has been incredible,” said John Canavan, an analyst at Oxford Economics. “It is also not over yet.”
At the crux of the issue is a financial system awash with cash with few viable short-term places to park it. The Fed’s so-called RRP facility has become the market’s “relief valve”, according to Canavan, giving investors an alternate place for safekeeping.
Excess reserves in the banking system have ballooned since the start of the year due in part to the Fed’s purchases of $120bn of Treasuries and agency mortgage-backed securities each month, along with the federal government doling out stimulus cheques to aid the pandemic recovery. Money market funds have attracted inflows as banks try to shift deposits to such funds for regulatory reasons.
Compounding the situation, the supply of short-term debt has shrunk at the same time as demand has risen, partly because the Treasury has scaled back the stock of bills in favour of issuing longer-term debt.
Joseph Abate, a money market strategist at Barclays, said the facility was working as intended to absorb the extra cash in the system at a time when Treasury bills with a maturity of less than one month are trading with negative yields.
Some short-term US government debt was quoted at yields of minus 0.01 or minus 0.02 percentage points on Thursday.
“Large balances in the RRP indicate that while rates in the bill and repo market are pinned at zero, the RRP is effectively mopping up the excess liquidity and keeping rates from trading below zero,” he said.
Investors are keeping a particularly close eye on the federal funds rate, the Fed’s main policy rate, which has dropped along with other short-term rates and now sits well below the middle of the central bank’s 0-0.25 per cent target range. It was quoted at 0.06 per cent on Thursday.
Market participants speculate a move to 0.05 per cent could spark further action from the central bank.
The Fed has signalled it is open to raising the RRP rate or the interest it pays banks on reserves they hold at the central bank to ensure the fed funds rate does not drift further lower.
“The Fed’s role in money markets is only growing,” said Priya Misra, global head of rates strategy at TD Securities. “Clearly the market is not functioning on its own.”