Fed’s Ability to Set Rates Floor Is Weakening on Cash Deluge


The Federal Reserve’s floor for overnight funding markets is proving to be no match for the deluge of cash. 

Money-market securities ranging from Treasury bills to repurchase agreements continue to trade below 0.05% -- the offering rate on the overnight reverse repo facility, which is supposed to act like a floor for the front end. The Fed at its June meeting had raised the rate by five basis points to help support the smooth functioning of short-term funding markets.

Still, usage of the tool climbed to a record $1.136 trillion on Monday, eclipsing the previous high of $1.116 trillion on Aug. 18. 

Fed’s Ability to Set Rates Floor Is Weakening on Cash Deluge

Demand for the so-called RRP facility has surged as a flood of dollars threatens to overwhelm funding markets. That’s in part a result of the central bank’s long-standing asset purchases and drawdowns of the Treasury’s cash account, which is pushing reserves into the system. As a result, liquidity has been swelling, especially as the Treasury cuts supply to create more borrowing room under the debt ceiling.

The pressure pushing down overnight rates toward zero is proving a major headache for money-market funds. It hampers their ability to invest profitably, and can lead to further disruptions as they begin to waive fees to avoid passing on negative rates to shareholders. A number of firms including Vanguard Group shut down prime money-market funds last year after struggling to cover operating costs in the low-interest-rate environment.

Not Panacea

“The Fed’s technical adjustment earlier this year is not a panacea for the money markets,” JPMorgan Securities strategists Teresa Ho and Alex Roever wrote in a note. “Supply and demand technicals remain an overarching driver of rates, and with the supply and demand gap now having grown to $1.35 trillion, it’s not surprising that the Fed’s ON RRP is providing only a soft floor for money market rates.” 

The strategists predict the distortion will linger even after the Fed begins reducing asset purchases from the current level of $120 billion per month. Even if the central bank were to complete tapering by August 2022, as JPMorgan expects, there may still be an additional $850 billion to $1 trillion of additional liquidity injected into the financial system. 

While Treasury bill supply is expected to rebound once the debt-ceiling limit is resolved, it’s still unclear when that will happen. Bills maturing at the end of October and through November are yielding more than the securities surrounding those dates. 

©2021 Bloomberg L.P.

BQ Install

Bloomberg Quint

Add BloombergQuint App to Home screen.