Money market rates continued to decline to punishingly low levels in the latest week, pressured downward by a further increase in the monetary base, which is resulting from the Federal Reserve’s asset-purchase program. Banks, which hold about 20% of their assets in fixed-income securities, have since the Fed’s program began throttled back their steady accumulation of fixed-income securities, if only because the Fed is forcing their hand.
The liquefying of bank balance sheets is just one symptom of a systemic condition whereby financial liquidity is superfluous in magnitude substantial enough to encourage investors to do what the Fed ultimately intends them to do, which is to move out the concentric circle—to rebalance their portfolios and take added risk, buoying riskier assets. Combined with a continuing contraction in the supply of investable money market assets, the result is as it has been, which is an ever-lower level of money market rates. The nearing of quarter-end is adding to the downward pressure on rates.
No meaningful relief on the downward pressure on money market rates is expected until Washington approves an increase in the debt ceiling significant enough to restore the supplemental financing program and hence increase the supply of T-bills.
T-bill and repo rates highlight the downward pressure on rates in the money market realm. For example, 3-month T-bill rates fell to 0.7% on Friday from 0.12% the previous week and a range of 0.14% to 0.16% at the start of the year. 6-month bills fell to 0.13% from 0.15%, while 52-week bills fell to 0.22% from 0.25% the previous week. The overnight repo rate, which is the rate paid in exchange for Treasury securities held overnight, fell to 0.13% from recent levels of about 0.15%. The repo market is roughly $2.8 trillion in size.
Indicators of bank stress and potential systemic risks to the banking sector remain very benign. For example, forward rates on Libor-OIS (this basically measures the yield spread between LIBOR and bets on where investors expect the fed funds rate to be) are close to a 1-year low and Yankee banks (foreign banks that issue commercial paper in the United States) have increased their issuance of commercial paper, indicating comfort amongst investors in holding short-term debts of major foreign banks.
Suffice it to say, liquidity remains as dominant as ever as an influence on money market rates relative to credit-related influences. If there is a risk of upset to this equation it is in the increase in inflation expectations, which if sustained would pose risk of validation in forward rates, because the Fed, as William Dudley reminded investors on Friday, “will not be tolerated.” A sharp increase was reported Friday by the University of Michigan, which said that inflation expectations in its mid-March consumer sentiment survey had increased to a 3-year high.
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 " and co-author of the 1200-page book "."