Excess cash in the US financial system pressures the Fed’s policy rate

According to analysts, the Federal Reserve may need to recalibrate its set of policy tools, as an excess of cash that has passed through the US financial system has made it difficult for the central bank to maintain strict control. of its type of policy.

Short-term interest rates have fallen to record lows since the beginning of this year, as financial institutions that are aware of cash are competing to lend it on very low-risk vehicles, such as U.S. government securities that expire in the near future or so-called repurchase agreements.

“It is clear that there is a very large and insatiable demand. . . and it’s like a set of music chairs in terms of who can find the offer first, ”said Teresa Ho, JPMorgan strategist, who estimates there is a $ 751 billion supply demand gap in the funding markets in April.

The increase in liquidity comes in part from the Fed’s asset purchase program, in which it buys about $ 120 billion in U.S. public debt each month. Bank deposits changing money market funds, as well as the Treasury Department’s plans to pull off its cash record and pay funds associated with the recent stimulus package approved by Congress, have also increased reserve balances.

At the same time, the department has withdrawn its issuance of Treasury bills, which expire in a year or less, which has reduced the supply of a key asset that is used to store cash.

Large amounts of cash have returned to the Powered, with the demand for the central bank’s reverse replacement facility (which gives financial companies a place to park it temporarily). Last week’s daily usage rose to its highest level since 2017 and reached $ 369 billion on Friday.

These factors have pushed the Fed’s benchmark interest rate to a level that has begun to attract more control from analysts and investors.

The federal funds rate stands at 0.06%, well below the central bank’s 0-0.25% rate. A sustained mark below 0.05% could be enough to boost Fed action, said Morgan Stanley strategist Kelcie Gerson.

The Fed has already done that extended access in the reverse replacement program i high limits on the amount of cash, financial companies can park in the central bank from $ 30 billion to $ 80 billion in order to drain the liquidity of the system and curb the downward drift in short-term rates.

A next step could include raising the interest the Fed pays on banks for the reserves they have in the central bank, analysts say. Another is to increase the rate the Fed pays in its reverse replenishment program.

“The Fed is watching over this issue,” added Thomas Simons, an economist at Jefferies. “They don’t want to allow it to get out of hand.”