Can there be such a thing as too much money? There is certainly a huge amount of money sloshing through the US financial system, which is straining the short term funding market and threatening to push short-dated Treasury yields below zero. The expiration of a two-year suspension of the US federal debt ceiling at the end of July could further stress the market, making it more difficult for investors to earn a return on cash..

At issue is a worsening supply and demand imbalance in the short-term funding market. A recent analysis by JPMorgan puts the gap at roughly $1 trillion. A gusher of cash — much of it associated with COVID-19 pandemic relief — has poured into banks and money market funds, spurring demand for Treasury bills. But T-bill supply is shrinking as the government issues longer-dated securities and the US Treasury draws down its cash balance at the Federal Reserve in anticipation of a reinstatement of the debt ceiling.

The resulting supply-demand mismatch briefly pushed short-term Treasury yields below zero earlier this year and put downward pressure on the benchmark federal funds rate. Short-term Treasury yields were last trading negative in March 2020 as investors ploughed into cash amid market volatility early in the pandemic.

Fed puts a floor under rates

The Federal Reserve responded at its June meeting by adjusting its lesser known administered interest rates to help ensure front-end yields remain in positive territory. The Fed raised the interest rate on its reverse repurchase facility (RRP) to 5 basis points (bps) from zero and increased the interest rate paid on both required and excess reserves to 15 bps from 10 bps.

When a financial institution such as a bank, money market fund or government sponsored enterprise utilises the RRP, the Fed sells securities and receives cash with the promise to buy the securities back the next day. The Fed is effectively borrowing money, and the interest rate for the transaction helps to set a floor for other borrowers in the short-term market.

Usage of the RRP soared to a record of around $1 trillion at the end of June owing to the 5-bps interest rate increase and several steps the Fed has taken to expand access to the facility. After the 2008 financial crisis, the Fed expanded the list of counterparties that could access the RRP. This included money market mutual funds, government sponsored enterprises and banks in addition to primary dealers of the Federal Reserve Bank of New York. In April, the Fed eased requirements to make the facility more accessible to smaller funds. It has also raised the amount of cash participants can place in the RRP to $80 billion from $30 billion. Usage of the RRP could continue to rise because the abundance of short-term liquidity could persist for several months and T-bill supply could contract further as the Treasury looks to reduce its cash balance prior to the expiration of the debt ceiling suspension.

 

1. Source: Refinitiv Datastream. All figures in USD billions. Treasury deposits at the Fed are weekly data as of 28 June 2021. US Treasury bills outstanding are monthly data as of 31 May 2021.

 

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