The record pile of cash parked at the Fed facility should be reduced

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Growing demand for a U.S. Federal Reserve facility where investors hide cash overnight should weaken in 2022 after a record high last year as the shortage of low-risk assets that generate positive returns shrinks.

In 2021, investors parked record amounts of money in the Fed’s overnight reverse repo facility where cash is exchanged for ultra-safe securities like the US Treasuries. Daily RRP spending averaged $ 1.6 trillion in December, rising to a record $ 1.9 trillion on the last day of the year. The average daily usage for December 2020 was zero.

The facility, which acts as a last resort investment, has attracted increased demand throughout the year due to a lack of secure, short-term treasury bills, which has led investors such as money market funds to have less safe places to allocate their money.

But in 2022, the popularity of the RRP will begin to wane, strategists say, as the flood of money injected into financial markets to counter the harmful effects of the pandemic begins to subside. This will bring more alternatives for investors and potentially increase the wealth of money market funds that invest in current assets.

“We think we’re pretty close to the peak of the reverse repo overnight,” said Mark Cabana, head of U.S. rate strategy at Bank of America. “For money market funds, this means that they finally have other attractive alternatives. The only reason money market funds invest in the Fed is because it’s the worst option for them. “

The reduction in the issuance of treasury bills in 2021 – in favor of longer-term debt – is part of what has led to such high use of the RRP instrument. Moreover, the Fed’s massive bond-buying program has forced the central bank to increase the amount of cash flowing into the financial system.

Demand for money market funds, which are among the largest buyers treasury bills, was so high that the yields on government debt were briefly brought into negative territory.

Incentive money tied to multiple aid packages passed by Congress also raised Americans ’austerity rates, which in turn increased bank deposits. Banks, whose capital requirements were reintroduced in March, started with counseling clients to move their money from deposits to cash.

But after the enactment of the new law in lift the U.S. government borrowing limit in December, the treasury department is now expected to rebuild its cash balance and step up the issuance of short-term securities, providing much-needed relief.

From now until the end of January, Cabana said he expects the treasury’s cash balance to increase by approximately $ 600 billion.

Fed also in December announced to accelerate the reduction of its asset purchase program, helping to further mitigate the acute mismatch between the amount of cash sought in the home and the number of securities available for purchase.

Although RRP figures are eye-catching, Fed officials have expressed little concern about the facility’s record use in 2021. Asked about the seemingly insatiable demand for overnight cash parking at the central bank in July, President Jay Powell said the facility is ” did what he was supposed to do ”.

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

In order to maintain its effectiveness, the Fed has repeatedly adjusted the conditions of the instrument. The central bank has expanded the number of eligible parties that can join the RDP and increased the amount of money they can put into it each day – it made the adjustment only in September when it increased the counterparty’s daily limit to $ 160 billion.

It also started payment of interest on money left there overnight in June in an attempt to support the smooth functioning of the short-term financing market. The move came along with a decision to raise interest rates on excess reserves, which banks deposit with the Fed.

However, a senior Fed official recently cited increased use of the RDP as another signal that the central bank should move faster away from its ultra-appropriate monetary policy stance, which has been in place since its inception. pandemic.

“It’s pretty clear we can go faster on the balance sheet because I’ve looked at the RRP plant, and there’s about $ 1.5 trillion in reserves that are handed over to us every day from the financial sector,” said Christopher Waller, the governor, in mid-December as he exhibited case the Fed starts shrinking its balance sheet by summer. “We put so much liquidity into the system that the market doesn’t really want it.”

The benefits of increased bill issuance are likely to make the most significant contribution to the $ 4 billion money market industry after a busy year. Negative market returns in 2021 wiped out profits and forced funds to turn down new investors.

But money market stress could re-emerge later in the year, some strategists warn. Although the treasury is projected to bid more bills in the near future, debt issuance is expected to fall overall in 2022 as needs for financing fiscal programs are reduced.

“When the supply of bills increases more materially, it will withdraw some money from the RRP. But just the full size of the Fed’s balance sheet and reserve levels, I think will ensure that we see some pretty big numbers there on a daily basis for at least the next few quarters, ”said Ben Jeffery, strategist at BMO Capital Markets.

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