Negative Yields? A Tsunami of Liquidity is Pressuring the Cash Investor

By Thomas Urano, Principal & Managing Director

The money market community is struggling with a 0% yield environment and a mountain of cash threatening to drive money market rates into negative territory. What are the alternatives for short-term investors?

A year ago, the U.S. Treasury funded itself with a war chest of cash ready to spend on fiscal stimulus. Some may argue the Treasury substantially overfunded itself as the Fed’s general account, or “checking” account, topped $1.8 trillion by summer 2020. Over the last three months, the Treasury has spent down a large portion of this, putting over $600 billion back into the private sector.

The wave of cash flooding into bank deposits and money market funds is threatening to test the line in the sand between zero and negative yields. The Treasury has cut T-bill issuance this year, causing a reduction of $424 billion in net T-bill supply available to the market. The reduced supply of Treasury bills is making it difficult for money market funds to find suitable investment options for the inflow of cash. At near 0% yields, it becomes costly to maintain the infrastructure of a money market fund vehicle and incentivizes fund operators to pass costs along as negative yields or initiate a soft close of funds to new investors.

Enter the Fed. Through its Reverse Repo Facility (RRP) the Fed is taking in cash and paying out interest, essentially serving as the last stop investment option for cash. In an effort to prevent overnight rates from venturing into negative territory, the Federal Reserve has expanded its Reverse Repo Facility to almost $400 billion, up from zero in January.

Whether you look at T-bill yields, bank deposits, or RRP usage, all signs point to excess cash desperately in search of a home. Raising interest rates is the simple answer. Increasing RRP rates would drag T-bill yields off the floor and alleviate some pressure on other money market rates.

What are the alternatives for short-term investors? Enhanced Cash or Ultra Short Strategies invest just beyond the investable universe available to money market funds and inside of short-term fixed income strategies (1-3 year). An evaluation of the investment grade corporate bonds that have 1) 3-12 months to maturity, 2) are U.S.-dollar denominated, and 3) have more than $300 million in outstanding issue, shows that an opportunity for cash investors still exists. The size of this market is over $450 billion, the yield to worst is 0.38%, and with only a slight extension of interest rate sensitivity (0.5 year effective duration).

Absent further clarity on Fed policy, cash investors with flexibility would be well served to consider such alternatives to preserve the yield on their short-term investments.

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