The record amount parked in the Fed facility is about to shrink

Rising demand for the US Federal Reserve facility, where investors hoarded cash overnight is expected to decline in 2022 after a record surge last year, as asset shortages low risk produces diminished positive returns.

Investors have deposited record amounts in 2021 in the Fed’s overnight reverse return facility, where cash is exchanged for ultra-safe securities like US Treasuries. RRP daily usage averaged $1.6 billion in December, rising to a record $1.9 billion on the last day of the year. Average daily usage for December 2020 is 0.

The facility, which acts as an investment of last resort, has attracted such high demand all year as a shortage of safe, short-term Treasury bills keeps investors like market funds out of sight. currency right Fewer safe places to deploy their cash.

But in 2022, the RRP’s popularity will begin to wane, strategists say, as the influx of money into financial markets to combat the effects of the pandemic begins to become unlikely. This will bring in more alternatives for investors and potentially lift the fortunes of struggling money market funds that invest in short-term assets.

“We think we’re pretty close to hitting an overnight reverse repo top,” said Mark Cabana, head of US rate strategy at Bank of America. “What it means for monetary funds is that they finally have other attractive alternatives. The only reason money funds invest with the Fed is because it’s their least worst option.”

Line chart of Cash held overnight at US central bank's reverse repayment facility, billion dollars shows record-breaking demand for Fed facility expected to decline in 2022

The reduction in Treasury bill issuance in 2021 – for the sake of long-term debt – is part of the reason for the increased use of the RRP facility. Furthermore, the Fed’s massive bond-buying program forced the central bank to inject cash into the financial system.

Demand from money market funds, which are among the largest buyout funds in Treasury Bills, so high that it briefly pushed yields on government debt to negative levels.

The stimulus money tied to many of the aid packages passed by Congress also increased Americans’ savings rates, thereby increasing bank deposits. Banks, which in March reintroduced stricter capital requirements, start consulting customers transfer their funds from deposits into money funds.

But after the new law was passed to elevate The U.S. government borrowing limit In December, the Treasury Department is expected to rebuild cash balances and ramp up short-term securities issuance, providing much-needed relief.

Between now and the end of January, Cabana said he expects the Treasury’s cash balance to grow by about $600 billion.

Fed in December also announced that it would accelerate the downsizing of its property-buying program, helping to alleviate a severe mismatch between the amount of cash looking for a home and the amount of securities available to purchase.

While the RRP figures are eye-catching, Fed officials have indicated little concern about the facility’s use of record-setting 2021. When asked about the seemingly insatiable need to deposit cash overnight at the central bank in July, chairman Jay Powell said the establishment was “doing what it was supposed to do”.

Minutes from subsequent policy meetings also suggest a broad consensus within the Federal Open Market Committee that the facility is operating as intended.

To maintain its effectiveness, the Fed has repeatedly made adjustments to the terms of the facility. The central bank has expanded the number of eligible counterparties that can access the RRP and increased the amount they can put into it each day – an adjustment it made as recently as September when it raised daily partner limit to $160 billion.

It also started interest payment of funds held there overnight in June in an effort to support the smooth functioning of the short-term funding market. That move comes alongside a decision to raise the interest rate paid on excess reserves deposited by banks in the Fed.

More recently, however, a senior Fed official cited increased RRP usage as another signal that the central bank should move quickly from its already extremely accommodative monetary policy stance. apply since the start Disease.

“Obviously we can go faster on the balance sheet, because I looked at the RRP basis, and there’s about $1.5 billion in reserves being transferred to us every day from the sector. finance,” Christopher Waller, a governor, said in mid-December as he out case the Fed starts shrinking its balance sheet in the summer. “We put too much liquidity into the system that the market doesn’t really want.”

The benefits of increased bill issuance are likely to accrue most significantly to the $4 billion money market fund industry after a grueling year. Negative yields in the market in 2021 wiped out gains and forced funds to turn away from new investors.

However, money market stress could reappear later this year, some strategists warn. Although the Treasury is expected to auction more bills in the near-term, overall debt issuance in 2022 is expected to decline as demand for financing programs has declined. down.

“Once the bill supply increases physically, that pulls some cash from the RRP. But just the sheer size of the Fed’s balance sheet and the level of reserves, I think will guarantee that we’re going to see some pretty big numbers there on a daily basis for at least the next couple of quarters,” said Ben Jeffery , rates strategist at BMO Capital Markets said. .

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