Glut of cash in the financial system has strained the $4tn industry’s business model

A sector of the US financial industry concerned with saving $ 4 trillion for individuals and businesses has come under great pressure as US markets flirt with negative interest rates.

Money market funds that invest in short-term government debt have received hundreds of billions of dollars in new money from savers in recent months. But there is stiff competition to take advantage of a shrinking supply of low-risk assets that generate positive returns.

The result has been a contraction that has reduced yields on some debts below zero, rendering some swaths of the industry unprofitable and creating a challenge for the Federal Reserve, which analysts say may have to weigh to keep US interest rates positive.

If government money market funds have to continue to invest at zero percent, the industry economy “collapses,” said Christopher Tufts, global director of portfolio management for the money market business at JPMorgan Asset Management. “I wouldn’t be surprised if funds begin to limit investor subscriptions or shut down entirely to new ones. [money]. “

“It’s definitely not a nice place to trade at this hot moment in time,” said Deborah Cunningham, chief investment officer for global liquidity markets at Federated Hermes, one of the world’s largest money market fund managers. “There really isn’t much value anywhere.”

The downward trend in short-term interest rates has worsened in recent weeks as more cash has flowed into the financial system.

There has been a steady trickle from the Fed, which is buying $ 120 billion in Treasuries and agency mortgage-backed securities every month. The Treasury Department has compounded the situation by distributing funds associated with the Biden administration’s stimulus package approved in March.

At the same time, the Treasury has also been reducing the stock of outstanding short-term bills as part of its efforts to lengthen the maturity of outstanding government debt.

In some cases, investors have actually had to pay for the privilege of lending to the US government, as Treasury bills due in one month recently underperformed. The rate at which investors trade Treasuries and other high-quality collateral for cash on the repo market, another basic source of income for money market funds, has also turned negative at times.

Peter Crane, editor of Crane Data, estimated that the seven-day average return for top-tier government money market funds now hovers around 0.02 percent, well below the 1.39 percent level seen at the end of 2019. The Most money market funds have waived Commissions for investors, as they would consume the return offered.

Despite the meager returns, assets in government money market funds rose above $ 4 trillion for the first time in the week ending May 26, according to data from the Investment Company Institute.

Some of these inputs come from banks that have been urging large corporate clients to direct cash to money market funds rather than depositing it into their accounts. Executives at US banks say they are struggling to use the cash accumulating in deposit accounts, creating stringent capital requirements that they would rather avoid.

Money market fund managers with few good investment options have increasingly turned to the Fed, which offers certain banks and investment groups a place to store cash overnight through its reverse buyback program (RRP). at an interest rate of zero percent.

A record $ 485.3 billion was spent last week, earning nothing, and according to Doug Spratley, head of T Rowe Price’s cash management team, it has become “crucial” for the industry.

“If we need guarantees for the day, and we get negative rates on the street or zero rates even on the street, we will go to the Fed and consider it to be the correct trade for the day,” said Cunningham of Federated Hermes. “When others hit the more expensive prices, the Fed at zero has value.”

The Fed itself faces pressure to intervene in markets in the short term. Its benchmark rate, the federal funds rate, has fallen along with other short-term rates and is now well below the middle of the target range of 0% to 0.25%. It recently fell 0.01 percentage point to 0.05 percent, according to the central bank’s New York branch, a level that many rate strategists believe could force the Fed to act.

Richard Mejzak, head of global portfolio management at BlackRock’s cash management group, expects an increase in both the RRP rate and the interest the Fed pays banks on the reserves they hold at the central bank, perhaps as much as soon as the next monetary policy meeting this month.

Without some relief, the “longevity” of the money fund industry could be at risk, warns Mark Cabana, rate strategist at Bank of America.

“The money funds have already waived the fees and are earning practically zero,” he said. “There are questions about how long money funds can remain viable as a loss-making entity.”