Rising demand for a U.S. Federal Reserve facility where investors store cash overnight will decline in 2022 after a record run last year as a shortage of low-risk assets that generate positive returns eases.
Investors have parked record amounts of money in 2021 in the Fed’s overnight reverse repo facility where cash is being exchanged for ultra-secure securities such as US treasuries. Daily use of the RRP averaged $ 1.6tn in December, rising to a record $ 1.9tn on the last day of the year. Average daily use for December 2020 was zero.
The facility, which serves as a last resort investment, has attracted such increased demand throughout the year due to a shortage of safe, short-term treasury bills that investors like money market funds with less safe places to deploy their cash.
But in 2022, the popularity of the RRP will begin to wane, strategists say, as the flood of cash injected into financial markets to counteract the damaging effects of the pandemic begins to unfold. This will bring more alternatives for investors and possibly increase the fate of struggling money market funds investing in short-term assets.
“We do think we’re pretty close to seeing a reverse repo overnight,” said Mark Cabana, head of US exchange rate strategy at Bank of America. “What this means for money funds is that they finally have other attractive alternatives. The only reason money funds invest with the Fed is because it is their least weak option. “
Cuts in the issuance of treasury bills in 2021 – in favor of long-term debt – were part of what drove the use of the RRP facility so high. In addition, the Fed’s massive bond buying program has caused the central bank to inflate the amount of cash flowing into the financial system.
Demand for money market funds, which are some of the biggest buyers of Treasury bills, was so high that it briefly drove government debt yields into negative territory.
Stimulus money linked to the multiple aid packages passed by Congress also lifted Americans’ savings rates, which in turn increased bank deposits. Banks, which reintroduced stricter capital requirements in March, start with counseling customers to move their money from deposits to money funds.
But following the adoption of new legislation to light the US government’s borrow limit in December, the Treasury Department is now expected to rebuild its cash balance and sharpen its issuance of short-term securities, which provide much-needed relief.
Between now and the end of January, Cabana said it expects the treasury’s cash balance to rise by about $ 600 billion.
The Fed in December too announced that it will accelerate the downscaling of its asset-buying program, which will help further alleviate the acute mismatch between the amount of cash a home seeks and the number of securities available for purchase.
While the RRP figures are striking, Fed officials have shown little concern about the record use of the facility in 2021. When asked about the seemingly insatiable demand to park cash overnight at the central bank in July, chairman Jay Powell said the facility was “do what it is supposed to do”.
Minutes of subsequent policy meetings also suggested broad consensus across the Federal Open Market Committee that the facility operates as intended.
To maintain its effectiveness, the Fed has repeatedly made adjustments to the facility’s terms. The central bank has expanded the number of qualifying counterparties that have access to the RRP and increased the amount of money they can put into it every day – an adjustment it made as recently as September when it raised the daily counterparty limit to $ 160. billion.
It also started to pay interest on the money held there in June in an effort to support the smooth functioning of short-term finance markets. That move came with a decision to increase the interest it pays on excess reserves, which are deposited by banks with the Fed.
More recently, however, one senior Fed official cited increased RRP usage as another signal that the central bank needs to move faster away from its ultra-accommodative monetary policy stance that has prevailed since the beginning of the pandemic.
“It’s pretty clear we can go faster on the balance sheet, because I looked at the RRP facility, and there are about $ 1.5 billion in reserves that are handed over to us every day by the financial sector,” says Christopher Waller. , a governor, in mid-December as he Explained the case that the Fed will start shrinking its balance sheet by the summer. “We put so much liquidity into the system that the market does not really want.”
The benefits of increased account issuance are likely to accrue most to the $ 4 billion money market fund industry after a grueling year. Negative returns in the market in 2021 wiped out profits and forced funds to turn away new investors.
However, money market stress may reappear later in the year, some strategists warn. Although the Treasury is expected to auction more bills in the near term, debt issuance is expected to decline in general in 2022 as funding needs for fiscal programs have declined.
“Once the supply of accounts increases significantly, it will pull some cash out of RRP. But just the sheer size of the Fed’s balance sheet and the level of reserves, I think will ensure that we get some pretty big numbers up there.” see a daily basis for at least the next few quarters, ”says Ben Jeffery, price strategist at BMO Capital Markets.