Negative rates have US funds urging the Fed to .... well, "pull their finger out"


ref :- "Negative rates put $4trn savings industry under heavy strain" , The Financial Times, Companies and Markets


Not so very long ago (in the greater scheme of things), the concept of negative rates in the US seemed almost unthinkable. Even as central banks in other parts of the world put policies in place that embraced the idea to stimulate post-financial crisis economies and to fight deflation, the strength of the US economy meant that the US Federal Reserve had neither the need to follow suit, nor it seemed the inclination .... concern remains over the possible long-term, detrimental effects of negative rates. But in a huge (and key) area of the US finance industry, that's what they've been seeing.


Money market funds invest in short-term, highly liquid, top-quality debt for their investors .... largely, that means US Treasury Bills. This is definitely NOT an outlying sector of the investment industry. The amount invested by individuals and corporates in these funds is no less than $4trn, a mark that was hit for the first time on May 26th. A wave of new money chasing a yield (any sort of yield) in safe and liquid instruments has forced rates of return down so low that T. Bills maturing within one month have recently yielded less than zero. To be clear, that means that investors are PAYING to lend money to the US Government. The same thing is happening in the Repo (Repurchase Agreement) market, another area where money market funds are active.


** Reminder (or for newcomers): REPO: one party sells a security to another with an agreement to buy it back in the future (usually the following day) at a slightly higher price. The difference in price equates to a rate of interest. If you sell a security and repurchase it in the future, you are undertaking a Repo, and if you buy the security and sell it in the future it's termed a Reverse Repo.


Recent events have been something of a perfect storm for Money Market Fund managers. The Fed may or may not be philosophically averse to the principle of negative rates, but the pandemic forced them to lower short-term rates as far as they could go without stepping into that territory -- the Fed Funds rate (the rate at which banks lend/borrow excess funds with each other) is a band of 0.00 to 0.25%. But there's a lot more to it than that :


-- The Fed is buying $120bn of longer Treasuries (mostly) per month in order to keep longer yields down but inevitably that suppresses yields at the shorter end too


-- The US Treasury is handing out huge sums as part of President Biden's stimulus package


-- The Treasury is also in the process of lengthening the maturity of its debt, i.e. issuing less short-term and more long-term paper. Even if demand remained constant (it's not, it's increasing), fewer T. Bills to buy = higher prices = lower yields


-- Banks have been persuading large corporate clients to put their cash into money market funds instead of depositing it into their accounts with themselves. The latter option would force capital requirement obligations on the banks that they would rather do without.


In light of all that, one can understand how the yield on debt has traded below zero (as has the repo rate, incidentally). But this is a big problem. Fund managers have ceased charging fees to their investors ..... if 0.00% yield is suddenly the best deal out there, there's nothing by way of returns to cover anything like fees. And it's quite likely that funds will limit investment, or even close to new investment entirely.


If money market funds cease to operate as viable investment vehicles for any period of time, no one's quite sure what the ramifications might be. Which is why the Fed is under pressure to lift short-term rates .... Fed Funds currently trade at 0.05%, for example ... and why many high-profile payers are saying that they need to do something SOON. How about at the next monetary policy meeting on June 15th/16th ?



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