JPM: New Questions for New Year
JP Morgan Securities released a special commentary entitled, "The New Year Means New Questions for US Money Market Rates." It says, "The FOMC's decision to hike rates on December 16 launched the first stage of an interest rate discovery process for the US money markets. With the hike taking place so late in the calendar year, many money market participants had already begun to commit funds over year-end, leaving behind relatively thin markets where yields achieved may not be reflective of longer-term behavior. Stage two of the rate discovery process begins today as funds parked over year-end begin to roll-off, and will need to be redeployed. Over the next few weeks, we expect to get a more robust understanding about the levels and relationships between the various money market rates. In general, we think the relative relationships between the rates on various instruments and IOER - ON RRP band will tend to hold, although levels may drift a few basis points from initial, post-liftoff levels. These are the factors we are monitoring most closely in the coming days: Where will the Fed funds effective rate set? FFE sets in arrears, meaning the rate posted today reflects the previous trading day's activity. Therefore, the 20bp posted today reflects trading on the last day of the year. We suspect FFE set at this low level because GSEs (and perhaps a few banks) were unable to access higher yielding options with their cash. With a practically unlimited supply of ON RRP available at 25bp and IOER at 50bp, the 20bp print on FFE suggests that cash was structurally unable to tap other options.... We suspect that this mismatch between buyers and sellers in the Funds market was a year-end phenomenon, and the market will return to something near an IOER less 12-14 range in the coming days.... What will happen with Fed RRP demand? The Fed's ON RRP had a record take-up of $475bn on 12/31, a testament to both the high levels of cash in the financial system and the lack of higher yielding alternatives available to non-banks. Aggregate dealer balance sheet available to the overnight market fell going into year-end, and yields on bills maturing in 13-weeks or less remained persistently below 20bp.... We expect use of the Fed RRP facility to remain higher than pre-liftoff levels, particularly if yields on short dated bills and agency discount notes remain low. If this proves to be the case, the ON RRP will likely attract persistently high interest from government money market funds. Today, demand for On RRP fell to just under $200bn, confirming the year-end surge was calendar related. What will happen with Treasury bill yields? With the Fed providing higher yielding alternatives for MMF and foreign central banks, demand for bills should ease somewhat. But with net bill supply set to drop about $36bn the first two weeks of the year, higher yields may be slow to develop. Looking ahead for the next few weeks, we expect yields on 13-week and shorter bills to remain sub-IOER, while yields on longer bills will continue take their cue from OIS markets."
