Tsunami of Cash Threatens to Pin Funding Rates at 0% Until 2022
(Bloomberg) -- The amount of cash sloshing around in U.S. dollar funding markets looks unlikely to abate anytime soon and that’s set to put downward pressure on short-term rates until next year unless officials act to alter the situation.
That’s the view of strategists at Bank of America Corp., who foresee further increases in usage of the Federal Reserve’s reverse repurchase agreement operation -- a facility that’s become a go-to place for parking cash. While it offers absolutely zero yield, the facility at least doesn’t charge investors for the privilege of keeping cash there, which is effectively what happens when yields go negative.
That’s something that has happened in other parts of the money markets, with the abundance of cash driving down yields on instruments ranging from repurchase agreements to Treasury bills, in some cases below zero. And that in turn has fueled demand at the so-called RRP facility, which on Wednesday surged to $450 billion, the third-highest on record.
Related Story: Cash Glut Drives Usage of Fed Reverse Repo Above $450 Billion
“The U.S. front end is awash with cash and there is limited reprieve in sight,” Bank of America strategists Mark Cabana and Olivia Lima wrote in a note to clients ahead of the most recent operation. “The wave of Fed cash is likely to continue drowning out any material front-end yield.”
The glut at the front-end has been spurred by the central bank’s ongoing asset-purchase program, commonly referred to as quantitative easing, as well the drawdown of the Treasury’s general account. The latter has been driven by the looming debt-ceiling reinstatement, which is due to take place at the end of July, and the flow of pandemic stimulus funds to taxpayers. Federal relief payments to state and local municipalities are also adding to the glut, and that is being exacerbated as regulatory constraints encourage banks to turn away deposits, directing that cash into money-market funds.
The Bank of America strategists, writing in a note to clients Wednesday, highlighted a number of potential options for officials to lean against the influx and alleviate the persistent downward pressure on the front end. These include:
- Potential tinkering by the Federal Reserve with so-called administered rates -- the offered yield on its RRP facility and interest on excess reserves, or IOER
- The Fed allowing Treasury bills in its portfolio to mature
- The Fed to start tapering its asset purchases
- The Treasury planning to hold a higher cash balance after the debt-ceiling hurdle is overcome
But absent measures along these lines, they see cash continuing to pile up at the RRP facility, where around three quarters of new cash has landed since March, in their estimation. Cabana and Lima predict that usage could climb to $475 billion by the end of this month -- which would be above the record high from 2015 -- and reach more than $800 billion by the end of July.
This also means that with persistently low interest rates, trading opportunities in the front-end are limited. Cabana and Lima are “now less convinced” that there will be steepening of the September-to-December curve for spreads between forward rate agreements and overnight index swaps, while they also expect March 2022 FRA-OIS spreads to tighten further. The market witnessed a flurry of activity on Wednesday potentially related to this call, with a large buy flow in September 2021 eurodollar futures helping to drive volumes on that contract well above average.
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