Allspring Money Market Funds writes in their latest monthly "Overview, Strategy, and Outlook" publication, "For our funds, we continue to focus on what the FOMC is saying and positioning for future policy rate increases. Since we tend to take a conservative approach when constructing our portfolios and favor keeping excess liquidity over the stated regulatory requirements, running shorter weighted average maturities and looking to extend if the opportunity offers a favorable risk/reward proposition has allowed our portfolios to capture these rate increases fairly quickly. In addition to capturing higher yields, the enhanced levels of liquidity allow our portfolios to meet the liquidity needs of our investors and help buffer net asset value (NAV) volatility."
Discussing the "U.S. government sector," they comment, "Although the Fed's rate path deserves and receives much attention, including being addressed above, the degree to which demand overwhelms supply in the government money markets continues to make life difficult for investors in the front end of those markets. In a sense, the Fed's rate setting is the macro picture while the market conditions are the micro environment in which investors operate. The macro has been terrific for investors ('to the moon, Alice') while the micro pressure has meant investment yields on government securities have lagged the Fed's moves."
Allspring says, "The best indicators of the supply/demand imbalance are Treasury bill (T-bill) market levels, Fed reverse repurchase (repo) program (RRP) usage, and repo market behavior as reflected in Secured Overnight Financing Rate (SOFR) settings."
They explain, "T-bills maturing within the next month have routinely traded 40 bps to 50 bps through the Fed's RRP level of 1.55%, the presumed rate floor in the government money markets. This reflects the pressure that investors without access to the RRP have brought on rates in buying because they must (for example, in the case of 100% Treasury money market funds) or because they consider it their best option, all while T-bill supply has fallen fairly significantly for most of the year, by just over $500 billion since February. Rarely have T-bills been so expensive relative to traditional alternatives such as repos."
The Overview states, "While we only see the footprint of the imbalance in T-bill market yields, we can actually measure the imbalance itself by looking at RRP usage <b:>`_.... The RRP is where money goes when it has no better home, and its usage grew from essentially zero to its current $2+ trillion as the Fed's balance sheet grew over the two years of pandemic quantitative easing (QE). By design, QE creates money, either in the form of bank reserves or other liquidity, and much of it found its way into the RRP. Although QE ended in March, the RRP is still growing, probably largely because savers grow less tolerant of stagnant bank deposit yields with each passing Fed rate hike. That same phenomenon is likely at play in the T-bill demand discussed above."
It continues, "Repo market yields have typically stuck closer to the RRP level, but even they have recently cracked under the weight of demand.... In the roughly nine months following the Fed's placement of the RRP rate at 0.05 in June 2021, the SOFR set exactly at the RRP rate on all but 10 days, and even then the variance was usually just 1 bp-2 bps at the most. Since mid-March this year, SOFR has usually set below the RRP, equaling it on only 13 days, and in the past few weeks it has set as much as 11 bps below the RRP."
Allspring adds, "While a rising tide (i.e., Fed hikes) lifts all boats, T-bills and other government instruments appear to be more like submarines lately. The good news is that, in the bigger picture, we are probably roughly at the extremes of the imbalances, at least in this cycle. That's not to say imbalances will resolve and rates revert next week, or next month, or even next quarter. But the T-bill supply contraction should turn around to net supply sometime in the third quarter, and QE morphed into quantitative tightening (QT) in June as the Fed began its briefly awaited but long-running balance sheet contraction. With QT, the Fed has begun removing liquidity from the financial system, and we should eventually see that combine with the improved T-bill picture to shrink the RRP balance."
J.P. Morgan also discusses RRP in its latest "Short-Term Market Outlook and Strategy." They write, "As for MMFs, they have benefited from the series of rate increases YTD, with their net yields having moved up by about 120bp and 140bp to 1.23% and 1.45% for government and prime funds, respectively.... Furthermore, the net yield spread between prime and government MMFs has now widened to 20-25bp, levels last seen in 2019. While MMF reform remains a concern, it appears shareholders are ignoring that for the time being as prime MMF AUMs have increased by $49bn YTD (prime institutional: +$29bn, prime retail: +$20bn). To the extent MMF shareholders are looking for a place to temporarily hide out from the volatility in both the equity and fixed income markets, prime MMFs are an attractive choice relative to government MMFs and bank deposits."
Discussing the "haves and have nots <b:>`_," JPM tells us, "The rally in T-bills this year has been relentless as the lack of supply has driven many liquidity investors to bid T-bills significantly below RRP but above deposits. Yields of 1-3m T-bills have continued pushing substantially lower and are now trading 32-47bp through OIS.... Faced with limited supply options and no access to the Fed, certain liquidity investors have been feeling the pain. Meanwhile, investors with access to the Fed's balance sheet, predominantly MMFs, have had some reprieve."
They explain, "As intended, RRP has been doing its job and is helping to provide a floor, albeit a leaky one, for money market rates via MMFs.... MMFs have seen their T-bill holdings decrease by $1tn over the past year (April '21 to April '22). Meanwhile, RRP balances have increased by $1.7tn. Assuming all T-bill holdings were reallocated into RRP, this means that the reduction in net T-bill issuance over the past year has contributed to about 75% of the increase at the RRP."
JP Morgan's piece adds, "Perhaps more notably, with MMFs having turned to the RRP as a source of supply, this has allowed other liquidity investors to step in. Indeed, T-bill holdings among investors that do not have access to the Fed's balance sheet increased by $290bn over the past year.... As of the end of April, we estimate that they now represent 51% of the market versus 36% last April."
Finally, they comment, "Even so, as we noted, the availability of RRP has not been enough to provide a hard floor for money market rates due to 1) limited investor access and 2) the sharp supply-and-demand imbalance in the front end. Beyond MMFs, other investors such as GSEs have also increased their RRP usage over the past year.... [I]n April, GSEs contributed $139bn to the RRP versus zero during the same period last year. Perhaps it was no surprise that the Fed might consider further increasing the per-counterparty RRP limits, as revealed in the June FOMC meeting minutes. Overall, the supply-and-demand imbalance will likely persist and continue to pressure the front end. Until that pressure fades -- which we don't expect until 2023 -- T-bill valuations will remain rich."
