The 2008 financial crisis saw short-term USD rates drop close to zero, and for the last decade, low interest rates have continued to dominate the US liquidity landscape. The current challenging environment has placed further strains on these short-term rates. As organisations faced an increasingly uncertain market landscape, between mid-March and the end of April, over US$1trn moved into government and treasury money market funds (MMFs).
The abrupt increase in demand, occurring in such a short window, temporarily pushed T-bill and overnight treasury repo rates below zero at times. Elsewhere, credit spreads on LIBOR rates widened in March. While T-bill and overnight treasury repo rates have since turned positive, and LIBOR rates have come down considerably, the rates used for USD MMFs continue to grind lower.
In this unprecedented period, where businesses continue to face historically low interest rates, what is being done and what can businesses do to help mitigate the impact of the new liquidity ‘norm’, ask BNY Mellon’s Tom Meiman, Product Line Manager for Liquidity Balances and Demand Deposit Account Services, Treasury Services, and Sam Schwartzman, Head of the IMG Cash Solutions Group.
In March 2020, swift regulatory and legislative action was taken in the US. For example, effective from 26th March, the Federal Reserve reduced the reserve requirement ratio for banks to zero on deposits, freeing up additional liquidity for banks to use to lend to individuals and businesses. The following day, the President signed the Coronavirus Aid, Relief and Economic Security (CARES) Act – a US$2trn stimulus package – into law.
Elsewhere, the supplementary leverage ratio (SLR) – a non-risk weighted capital metric that affects large banks – has been temporarily adjusted, with bank holding companies no longer required to factor Fed positions and treasury holdings into this metric. This has also allowed banks to free up their balance sheets, enabling them to extend credit and provide more liquidity to the market.
The Fed has also established a number of other programmes to free up additional liquidity, including the Money Market Mutual Fund Liquidity Facility (MMLF), the Municipal Liquidity Facility (MLF), the Main Street Lending Program and the Term Asset-Backed Securities Loan Facility (TALF).
While the long-term impact of the pandemic, as well as the effectiveness of the various legislative and regulatory actions, is not yet known, treasurers and risk managers will continue to face uncertainty for the foreseeable future. Against this backdrop, it is important to consider the projected outlook for short-term market rates.
Currently, the federal funds rate is expected to stay very close to zero, with the target range likely to remain between zero and plus-25 bps. Elsewhere, T-bill rates, after steadily rising in the aftermath of the initial crisis have now begun to decline of late. Should rates begin to increase again, banks may begin to move deposits away from the Fed into the T-bill market, which could cause a near term cap on rates. LIBOR rates are predicted to remain relatively flat going forward.
Though MMF yields remain somewhat positive, a lag effect, created by securities still being held that were purchased prior to the two Fed interest rate cuts in March, needs to be factored in. As these securities mature and new cash is reinvested at current rates, it is likely that these yields will continue to grind down. In fact, it is expected that government treasury repo fund yields will fall to one (1) bp during the next two months, at which point the fall is likely to stop.
Assuming current market rate predictions are accurate, it is important to note that MMF yields are not expected to go negative – even though certain expense waivers may be necessary to keep the minimum yield on some funds above zero.
So what tools can cash managers employ to effectively optimise their excess operating cash? The recent volatility has led to an influx of cash into the short-term market space, with a particular drive towards bank deposits.
The key instruments being utilised include deposit accounts, such as Demand Deposit Accounts (DDA), sweeps, hybrid accounts and money market deposit accounts, as well as investment accounts, such as the direct purchases of securities, MMFs and the increasingly popular FICC SMP repo product. Each individual tool delivers different benefits and can prove valuable to clients at different times, according to their individual strategies, liquidity goals and, of course, market conditions.
Businesses continue to face significant challenges when it comes to optimising their excess operating cash strategies. Although the Fed has stated that it will do all it can to avoid negative rates, with rates teetering closer to zero than ever, it is crucial that cash managers plan for an array of scenarios.
It falls to banks to help ensure their clients are equipped with knowledge regarding the shifting market, and apprised of the range of solutions necessary to react to and navigate the uncertain environment.
What’s more, organisations also need to be aware of the potential impact of using such tools if a negative USD rate were to come into effect. For example, on-balance sheet sweeps will likely stop, while off-balance sheet sweeps to MMFs – depending on the rate environment for those MMFs – may continue to operate.
Elsewhere, depending upon the responses of individual providers, earnings credits in a negative USD environment may cease. At the same time, there may be providers that continue to generate and apply ‘credits’ irrespective of the rate. In this scenario, balances could switch from non-interest bearing to interest bearing and become subject to negative interest under certain conditions.
Planning for a host of different eventualities has therefore become a vital part of any cash management strategy; helping to ensure that businesses are well-positioned and well equipped with a suite of solutions to react to effectively to incoming market changes – whatever the future holds.