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Crescenzi: The House of Pain — The Money Market

The money market has become an ever-worsening house of pain, owing to the Federal Reserve’s merciless effort to create an investment climate so punishing that it drives investors to seek refuge in other assets. This rebalancing effect is the essence of the Federal Reserve’s asset purchase programs—popularly dubbed QEI and QEII.

More of the same lies ahead, because the Federal Reserve will in the two months ahead put to bear further immense pressure on short-term rates by adding still-more financial liquidity to the current mountain that already exists. This will no doubt continue the exodus by investors from the money market realm, which will help other asset classes to flourish, just as the Fed hopes.

The pain inflicted on money market has in recent weeks been intense, as evidenced by the T-bill market, where yields have plummeted from an average of around 14 basis points in the six months ended in early March to about 6 basis points on Friday and just 4 basis points in today’s trading. The repo market—the biggest segment of the money market where investors swap their excess cash with cash hungry banks and primary dealers for Treasury securities (generally on an overnight basis), has also seen rates plummet, from an average of about 21 basis points in the six months ended in early March to as low as 3 basis points in today’s trading.

The Federal Reserve headquarters in Washington, DC.
The Federal Reserve headquarters in Washington, DC.

These rates are falling because the Federal Reserve is increasing the amount of financial liquidity in the financial system.

It does this when it purchases Treasury securities using its electronic printing press.

Another major influence of late has been the suspension of the Treasury’s Supplemental Financing Program (SFP), a $200 billion program whereby the Treasury issued Treasury bills in order to help the Fed manage its vast amount of reserves. The suspension was necessary to keep the U.S. from reaching its debt ceiling. The reduction in T-bill supply has reduced the investable universe of money market assets, pressuring interest rates still lower.

New influence on the money market came Friday when the FDIC’s fee assessment program was revamped. Beginning April 1st the FDIC began assessing fees on not just deposits, but also other liabilities, including repo. This has reduced the attractiveness of the repo market, which previously had benefited from the arbitrage banks engaged in when borrowing in the repo market at say 15 basis points and deposited the money at the Fed to earn the interest rate the Fed pays on excess reserves, now set at 25 basis points. With fees as much as 15 basis points or more, banks are shunning repo because it is only profitable if they can exchange their Treasury securities for cash at a rate that takes into account the fee they must now pay to the FDIC. This means the repo investor must accept a much lower rate than before.

Investors have reacted accordingly. AMG data indicate that the outflow from money market mutual funds has been $85 billion year-to-date, roughly the same amount that has flowed into mutual funds for stocks, investment-grade corporate bonds, and commodities this year. The rebalancing from money market assets to riskier longer-term assets is a desirable outcome for the Federal Reserve, which wants investors to move out the risk spectrum to boost asset prices stimulate the economy. The Fed wants the money market to be a house of pain where few investors will reside for long before they seek refuge elsewhere.

Tony Crescenzi is Senior VP, Strategist, Portfolio Manager Pimco. Crescenzi makes regular appearances on financial television stations such as CNBC and Bloomberg, and is frequently quoted across the news media. He is also the author of "Investing from the Top Down," "The Strategic Bond Investor," and co-author of the 1200-page book "The Money Market."