J.P. Morgan Securities released its "Short-Term Fixed Income 2022 Outlook" earlier this week, and the update, entitled, "The same, only different," tells us, "In 2022, the prospect of Fed rate hikes should meaningfully boost yields away from the zero bound, allowing money funds to recapture some fee waivers. The Fed's balance sheet and US fiscal policy will also play a much smaller role and fade in the background. Even so, the amount of excess liquidity in the money markets, and the broader financial markets, will remain substantial. At the same time, overall money market supply will remain anemic as Treasury is unlikely going to revitalize its net T-bill issuance. Much like this year, the supply-demand mismatch will continue to pose challenges for participants in money markets. Usage at the Fed RRP is unlikely going to see much relief any time soon."
They explain that, "[T]he pace of deposit growth at banks should slow materially given tapering and a rebound of Treasury's General Account to more normal levels. Moreover, banks will likely continue to face leverage constraints that limit their willingness to take on more deposits. We think this theme will continue to play a role next year in the absence of any SLR relief and given the tremendous amount of excess liquidity that already exists on their balance sheets."
The update continues, "Furthermore, deposit betas are unlikely to rise meaningfully even if the Fed begins to raise rates in 2H.... [D]uring the last tightening cycle in 2016-2018, deposit betas were very slow to rise at the start, only to catch up towards the back end of the tightening cycle. Meanwhile, MMF yields were much more sensitive to Fed rate hikes and market rates. All of this is to say that MMFs could attract more money next year, or at a minimum, maintain their current balances. On margin, MMF reform may offset some of these inflows, but we think the impact is small, as the reforms primarily target prime funds and not government funds. To that end, we wouldn't be surprised if RRP balances trend even higher, potentially to as much as $2tn."
J.P. Morgan writes, "Second, duration will likely remain a focus among many investors.... Attempts by long-end investors to shorten duration could boost demand in the front end of the curve. Indeed, AUMs at ultrashort and short-term bond funds have increased by $107bn or 12% YTD, predominately in the short-term sector.... While we don't anticipate the same growth in short-term bond funds next year given volatility in the 2y point of the curve, we could see a pickup in ultrashort bond funds, which tend to maintain a WAM of around 6 months."
They comment, "Third, sec lending reinvestment cash balances have surged to $750bn this year after hovering around the $600-$700bn range for many years (Source: RMA, JPMorgan). Our colleagues in sec lending have noted a combination of factors that are driving balances higher: 1) a growing short base in Treasuries, 2) a flat repo curve, which has allowed lenders to lock up more term funding, 3) higher equity valuations, which have resulted in higher cash collateral value, and 4) heavy new corporate issuance in 2021, which has brought forth more corporate GC collateral in the marketplace. In 2022, we believe many of these factors will remain in play given 1) the potential for upside surprises to inflation and employment, which could translate to a larger short base of Treasuries, 2) expectations that supply chains and COVID-19 will normalize in the coming year, boosting equity valuations, and 3) another year of strong corporate issuance, driven by financials."
The Outlook tells us, "Fourth, liquidity portfolios of states and local governments have increased meaningfully over the past two years, as they were beneficiaries of both the CARES and ARP fiscal stimulus packages. Importantly, states and local governments are expected to receive the second portion of the ARP fiscal payments in 2022. Combining that with increased tax receipts (which have so far outpaced spending), we would not be surprised if liquidity continues to accumulate among states and local governments next year."
It adds, "Last but not least, there continues to be a substantial amount of cash on corporate balance sheets, totaling $2.3tn as of 3Q21. Cash flow generation is strong among many of these corporations given consumer demand, as is their access to capital markets. To the degree that they are not spending as much on capex or increasing payouts to shareholders, this money will continue to accumulate. The top five corporate liquidity portfolios (AAPL, GOOGL, MSFT, AMZN, GE) currently have close to $615bn. All in all, regardless of when the Fed concludes tapering, liquidity will continue to be hanging around in the front end."
JPM also says, "In aggregate, we project total money market supply to increase by $655bn or ~5%, driven predominately by repo and Treasury coupons that are rolling into the money markets.... In fact, we estimate T-bill outstandings will decrease slightly by $37bn to $3.57tn, which would put the share of T-bills as a percentage of marketable Treasury debt in Treasury's recommended 15-20% range. The good news is that there are ~$380bn of Treasury coupons rolling into the money markets, which should give overall supply a marginal boost.... Likewise, we project net issuance in other parts of the money markets to be flat year-over-year. Our Agency strategists project total net disco issuance to be flat as FNMA and FHLMC continue to shrink their retained portfolios offset by marginal needs from FHLB to fund a minor rise in advances."
They state, "We look for financial CP/CD outstandings to rise moderately by $36bn as an increased demand for loans on the back of a recovering economy and the desire to boost trading activity, particularly among foreign banks, increase issuance.... In non-financial CP, we estimate balances will decline by about $30bn.... As for ABCP, we look for ABCP balances to be flat in 2022.... Perhaps the only real bright spot in money market supply is repo. In 2022, we think fundamentals favor growth in this sector, with balances rising by $200bn.... Overall, to the degree that dealers have capacity to expand their balance sheets, this will likely translate to higher repo balances among dealers and levered investors."
JPM summarizes, "For many short duration investors, the timing of liftoff and the pace of rate hikes will figure prominently in their asset allocation considerations next year. As the Fed initiates liftoff, short-term interest rates -- that is, the benchmarks on which floating rate notes (FRNs) are based—will begin to rise. As they do, the relative performance between front-end fixed and floating rate note securities will begin to shift, so it's worth understanding which asset class offers better value."
