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The usage of the Federal Reserve facility for overnight cash parking has reached its lowest level in a year, as US money market funds increase their holdings of government debt.
On Thursday, investors deposited $1.93tn in the Fed’s overnight reverse repo facility (RRP), representing the lowest amount in a year. This is a decrease of over $200bn from this month.
US government money market mutual funds, managing $4.5tn, prioritize the delivery of ultra-safe and ultra-liquid products with stable returns. However, due to volatility in Treasury bill yields caused by aggressive interest rate hikes by the Fed, these funds have turned to RRP for risk-free, predictable returns. A shortage of bills in recent years has also impacted their demand for RRP.
The RRP facility was established in 2014 as a means of absorbing excess cash in the financial system. Initially avoided by money funds, its usage has spiked in 2021, leading to concerns about liquidity in the banking system as banks struggle to retain deposits.
While analysts predicted a decline in RRP usage, the decrease has been slower than anticipated. This is due to short-term debt issuance by the US government that aims to replenish depleted coffers. Money funds remain hesitant to invest in Treasury bills, reflecting concerns about the direction of US interest rates in light of persistent inflation.
“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. The slower decline is attributed to Treasury bill yields not rising sufficiently to compensate for the risk associated with a potential Fed interest rate hike.
Brandon Swensen, a portfolio manager at BlueBay Fixed Income, revealed that their funds focus on short maturities and have not heavily invested in new Treasury bills. They are cautious about putting money into assets that do not account for future Fed rate hikes.
During periods of Fed rate hikes, Treasury bills in the market tend to reflect anticipated rate increases through higher yields. Although there has been a slight increase in Treasury bill yields this month following the Fed’s indication of two more rate hikes this year, they have not risen enough to fully reflect the risks of further rate increases.
The RRP currently offers an annualized return of 5.05%. In comparison, the rate on Treasuries, which carry more risk, is approximately 5.2%.
With money funds only selectively purchasing Treasury bills, other investors such as companies, state and local governments, and individuals have stepped in to fill the gap. This could further drain bank deposits, which have been decreasing since the collapse of several US regional lenders 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, head of Crane Data.
Cash flowing into the government’s coffers for new T-bills effectively leaves the banking system. Similarly, cash locked in the RRP facility reduces overall liquidity levels. If borrowing increases without a corresponding decline in RRP usage, it could strain the banking system further.
“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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