The banking system is swimming in nearly $4 trillion of reserves, thanks in part to the Fed’s asset purchases, a falloff in Treasury bill issuance and a rapid drawdown in the government’s store of funds at the Fed. The Treasury General Account, or TGA, has dropped by nearly $1 trillion since last fall, mirrored by the surge in bank reserves.
Nowhere is this more evident than in the rising popularity of a Federal Reserve program that lets firms stash their cash overnight with the U.S. central bank in exchange for at best a small return. The payout these days: Zero percent. But usage is soaring to record highs as money market funds and other eligible firms cope with what some analysts are calling a “tsunami” of cash. All that cash is pushing down short-term rates and increasing expectations, The FED might consider making a minor technical adjustment to rates in the coming months, if the downward pressure on overnight rates continued.
The effective federal funds rate - the central bank’s critical policy rate - slipped as low as 0.05% at the end of May before rising back to 0.06%. It is hovering near the bottom of the Fed’s target range of zero to 0.25%. The lowest it has ever settled on a daily basis is 0.04%.The central bank’s options for responding include lifting the interest it pays on excess reserves, or IOER, which is currently at 0.10% and is available only to banks. It could also lift the rate on the facility soaking up much of the extra cash: reverse repurchase agreements, or reverse repos, which are open to non-banks such as money-market funds. Together, the two are designed to form the “corridor” for the fed funds rate. The reverse repo rate - currently at zero - sets the floor by giving firms a risk-free place to park some of their cash overnight. Usage soared to a record $485.3 billion last week, up from nearly nothing in March.
Policymakers expanded access to the facility this year by loosening the eligibility rules and raising the daily limit on operations to $80 billion per user from $30 billion. But some analysts say the Fed may need to do more by boosting the rate from zero, perhaps by 2-3 basis points or its more typical move of 5 basis points. Any adjustments to reverse repo or IOER could happen at the June meeting or before, analysts say.
Many banks, unwilling to accumulate any more deposits, are funneling some of the excess reserves into money market funds. But with interest rates expected to stay low for the foreseeable future, money funds could struggle to find safe ways to invest that growing pile of cash to avoid losses for investors. While they can waive fees, fund providers still have overhead costs to cover.
The Fed could offer money funds some relief if it raises the rate it pays on reverse repo operations, But that wouldn’t address the longer-term financial stability concerns surrounding the funds, which sometimes have to sell holdings during times of stress in order to meet redemption requests. The central bank and other regulators have singled out money market funds, which the Fed supported at the height of the pandemic and more than a decade earlier during the global financial crisis, as an area that is ripe for more reform.
There’s a overall structural issue “It really is time to address it decisively.”