Surging demand for a US Federal Reserve facility where investors stash cash overnight is set to ebb in 2022 after a record run last year, as a shortage of low-risk assets that generate positive returns eases.
Investors parked record amounts of money in 2021 in the Fed’s overnight reverse repo facility where cash is exchanged for ultra-safe securities such as US Treasuries. Daily usage of the RRP averaged $1.6tn in December, surging to a record $1.9tn on the final day of the year. Average daily usage for December 2020 was zero.
The facility, which acts as an investment of last resort, has attracted such elevated demand all year because of a shortage of safe, short-dated Treasury bills that left investors such as money market funds with fewer safe places to deploy their cash.
But in 2022 the RRP’s popularity will begin to wane, strategists say, as the flood of cash injected into financial markets to counter the damaging effects of the pandemic begin to be unwound. This will bring more alternatives for investors and potentially lift the fortunes of struggling money market funds that invest in short-dated assets.
“We do think that we are quite close to seeing overnight reverse repo peak,” said Mark Cabana, head of US rates strategy at Bank of America. “What it means for money funds is that they finally have other attractive alternatives. The only reason that money funds invest with the Fed is because it is their least worst option.”
Cuts to Treasury bill issuance in 2021 — in favour of longer-term debt — have been part of what has driven usage of the RRP facility so high. Moreover, the Fed’s massive bond-buying programme has had the central bank pumping up the amount of cash flowing into the financial system.
Demand from money market funds, which are among the biggest purchasers of Treasury bills, was so high that it drove yields on the government debt briefly into negative territory.
Stimulus money tied to the multiple aid packages passed by Congress also lifted Americans’ savings rates, which in turn increased bank deposits. Banks, which in March had stricter capital requirements reimposed, began counselling clients to move their money from deposits into money funds.
But following the passage of new legislation to lift the US government’s borrowing limit in December, the Treasury department is now expected to rebuild its cash balance and ramp up its issuance of short-term securities, providing much-needed relief.
Between now and the end of January, Cabana said he expected the Treasury’s cash balance to increase by roughly $600bn.
The Fed in December also announced that it would accelerate the scaling back of its asset purchase programme, helping to further alleviate the acute mismatch between the amount of cash looking for a home and the number of securities available to buy.
While the RRP figures are eye-popping, Fed officials have indicated little concern about the record-setting usage of the facility in 2021. When asked about the seemingly insatiable demand to park cash overnight at the central bank in July, chair Jay Powell said the facility was “doing what it’s supposed to do”.
Minutes from subsequent policy meetings also suggested broad consensus across the Federal Open Market Committee that the facility was working as intended.
To maintain its effectiveness, the Fed has repeatedly made adjustments to the facility’s terms. The central bank expanded the number of eligible counterparties that can access the RRP and increased the amount of money they can put into it each day — an adjustment it made as recently as September when it bumped up the daily counterparty limit to $160bn.
It also began paying interest on the money held there overnight in June in a bid to support the smooth functioning of short-term funding markets. That move came alongside a decision to raise the interest it pays on excess reserves, which are deposited at the Fed by banks.
More recently, however, one senior Fed official cited elevated RRP usage as another signal the central bank should move away more quickly from its ultra-accommodative monetary policy stance that has been in place since the start of the pandemic.
“It’s pretty clear we can go faster on the balance sheet, because I looked at the RRP facility, and there’s about $1.5tn of reserves that are being handed to us every day from the financial sector,” said Christopher Waller, a governor, in mid-December as he laid out the case for the Fed to begin shrinking its balance sheet by the summer. “We put so much liquidity in the system that the market doesn’t really want.”
The benefits of increased bill issuance are likely to accrue most significantly to the $4tn money market fund industry after a gruelling year. Negative yields in the market in 2021 erased profits and forced funds to turn away new investors.
Money market stress, however, may reappear later in the year, some strategists warn. Though the Treasury is slated to auction more bills in the near term, debt issuance in 2022 overall is expected to fall as funding needs for fiscal programmes have dropped.
“Once bill supply ramps up more materially, that will pull some cash from RRP. But just the outright size of the Fed’s balance sheet and the level of reserves 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, rates strategist at BMO Capital Markets.