Money funds zero pain to worsen as fed maneuvers
By Bloomberg
Money-market investors who have endured almost-zero interest rates for about six years are bracing for even worse returns after the Federal Reserve limited how much cash it is willing to sop up.
The central bank is working out how best to control short- term rates after its bond buying policies aimed at suppressing borrowing costs and stimulate economic growth flooded the banking system with $2.71 trillion of excess reserves. The Fed, which is forecast to start raising rates next year, surprised market participants earlier this month when it placed a limit on how much cash it will take out of the system each night through its reverse repurchase agreement program.
The cap helped push overnight repo rates below what the Fed offers at its reverse repo program last week and sent Treasury bill rates below zero. That's adding to the pain of savers who have $2.5 trillion parked in money-market mutual funds, where yields have averaged 0.05 percent since the end of 2009, according to measures of the biggest 100 taxable funds compiled by Crane Data.
"Rates have already moved lower amid the uncertainty if the Fed's program with the cap will be able to create a floor," Thomas Simons, a government-debt economist in New York Jefferies Group LLC, one of 22 primary dealers that trade directly with the central bank, said in a Sept. 24 telephone interview.
Fed Move
The Fed at its Sept. 16-17 meeting placed a $300 billion daily limit on its reverse repo facility, a method under testing to temporarily take cash from counterparties including money funds and other non-banks and help set a floor under rates.
The central bank has spent the past six years quadrupling its balance sheet to more than $4 trillion in an effort to stimulate the economy, flooding the banking system with excess reserves. The Fed sought to limit its use of reverse repos based on concern that in times of stress, investors might flock to the central bank, starving the private system of liquidity
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In an overnight reverse repo, the Fed borrows cash from counterparties using securities as collateral. The next day, it returns the cash plus interest at a fixed-rate, now at 0.05 percent, to the lender and gets the securities back.
Repo Availability
The effect of the Fed cap is forecast to peak at the end of calendar quarters, including today, when dealers' balance sheet constraints are causing private repo availability to fall as much as 50 percent, according to Barclays Plc. On June 30, investors placed a record $339 billion overnight at the central bank.
Today, that demand may be about $100 billion beyond the Fed's $300 billion cap, according to Wrightson ICAP LLC.
Rates on money-market securities from bills to repos may slide further today if investors' aren't able to place needed cash with the Fed. Cash providers would be forced to find alternative investments and accept lower rates or leave cash idle.
Money market yields averaged 4.1 percent during the two years prior to the collapse of Lehman Brothers Holding Inc. in September 2008, according to Crane Data.
'Real Risks'
"The real risks for investors in money funds is that those balances may remain un-invested and placed with custodians where they get zero," Steve Meier, head of cash, currency and fixed- income at Boston-based State Street Corp.'s money-management unit, said in a telephone interview on Sept. 26.
In addition to the limited Fed facility, available securities for money-market investors have declined. Treasury bills outstanding total $1.45 trillion, down from a peak of $2.07 trillion in August 2009 when the government was financing a recovery from the worst recession in seven decades.
"There is a lot of liquidity in the front end of the money markets trying to find a relatively scarce number of places to go," Alex Roever, Chicago-based head of U.S. interest-rate strategy at JPMorgan Chase & Co. said in a telephone interview on Sept. 25.
Money-market mutual funds appeared in 1971 as a higher- earning substitute for bank deposits, whose interest rates were capped by the Fed. Thousands of households and businesses use them as a safe place to put cash, even as they lack federal deposit insurance.
SEC Rule
Regulators' have focused on reducing risks in the money- fund industry since the collapse of the $62.5 billion Reserve Primary Fund in September 2008 caused a run on institutional funds that helped freeze global credit markets.
The appeal of money funds for investors stems from stable pricing of $1 a share, implying that the value of the principal won't decline. For the riskiest of money-market funds, which can invest in securities such as commercial paper, the U.S. Securities and Exchange Commission adopted rules earlier this year that will require them to allow prices to float.
The quarter-end pressure on rates caused by the Fed's reverse repo limit is projected to worsen next year when the central bank is increasing benchmark rates. That's because policy makers, who are fine-tuning a way to exit the most aggressive monetary stimulus ever, expect to use the rate paid to banks on reserves to guide the fed funds rate higher, with the reverse repo rate helping to create a lower boundary.
Normalize Policy
To pull that off, the Fed's repo program might have to be as large at $1 trillion, according to Wrightson.
"To achieve their goal, they will have to raise the cap," Lou Crandall, chief economist at Wrightson in Jersey City, New Jersey, said Sept. 18 in a phone interview.
Simon Potter, head of the markets group at the Federal Reserve Bank of New York, which carries out the central bank's open-market operations, said last week that his staff would be monitoring the situation.
"We will continue to learn more about how these tools interact as we normalize policy and make adjustments over time," Potter said in a speech at the Japan Center for Economic Research in Tokyo on Sept. 25.
On days that bids for reverse reposexceed $300 billion, the New York Fed would use a process where the lowest rates submitted are accepted first until the cap is reached. For today only, repo operation will be held between 8 a.m. and 8:30 a.m. New York time, instead of the usual 12:45 p.m. and 1:15 p.m.
Until last week, a key measure of Treasury repo market rates calculated by the Depository Trust and Clearing Corporation hadn't traded below the Fed's overnight reverse-repo rate since Feb. 26, when the New York Fed increased it to 0.05 percent. On Sept. 22, the DTCC measure fell to 0.047 percent. One-month Treasury bills reached negative 0.0101 percent on Sept. 19, the most-negative level since July 2013.
"There are not enough high-quality short-term assets," Ronald Desautels, portfolio manager in Springfield, Massachusetts at Babson Capital Management LLC, the investment firm owned by Massachusetts Mutual Life Insurance Co., which has $205 billion in assets under management, said in a telephone interview on Sept. 25. "There is still a tremendous amount of money sloshing around in the money-market arena at minimal rates."