The Federal Reserve’s attempt to keep U.S. funding markets calm by rebuilding its cache of bank reserves could be expensive.
The Fed said Friday it will begin buying $60 billion of Treasury bills per month — with maturities ranging from five weeks to a year — at least through the second quarter of 2020 to improve its control over the benchmark rate it uses to guide monetary policy. It’s the central bank’s latest measure meant to prevent a repeat of the mid-September turmoil that rocked money markets.
But the Fed may have to pay up to convince people to part with the securities since investors are clamoring to hold bills. Money funds’ holdings of them topped $1 trillion in September, according to Peter Crane, president of Crane Data. “Funds love them,” Crane said.
Debbie Cunningham, chief investment officer of global money markets at Federated Investors, said if the company started to sell Treasury bills, it may be from shorter-dated holdings that it can easily invest in the market for repurchase agreements.
“That will be the exception rather than the norm,” Cunningham said in an interview. “They’re going to have to be buying them from other participants.”
Money-market reforms from 2016 spurred record inflows into government funds, driving demand for assets like repurchase agreements, Treasury bills and short-term agency debt. Regulations also require daily and weekly liquidity thresholds for money-market funds, and T-bills can satisfy those requirements.
“Everybody’s got bills somewhere, but it’s shaking those out in size that the Fed wants,” said Blake Gwinn, strategist at NatWest Markets. “I’m wondering what kind of premium the Fed is going to have to pay to get them.”
Even though primary dealer holdings of Treasuries are about $190 billion, their T-bill levels are quite low by comparison: around $7 billion. There’s not enough bills to buy just from the primary dealers, and so the Fed is going to have to convince other investors — like money funds or corporations — to part with their T-bills.
However, money markets — particularly the government ones — need the Treasuries, both as an investment vehicle, but also because they satisfy fund liquidity requirements. Fed purchases could drive yields down. If a money manager’s objective is to generate as much yield as possible for investors, why sell to the Fed at a lower rate? All that’s going to happen is the fund has to reinvest it in bills at a lower rate, reducing the yield the fund offers investors.
In addition to the Treasury bill purchases, the central bank said Friday that it will continue to conduct overnight and term repo operations through January, if not longer. The Fed has done liquidity injections like these since Sept. 17, and they’ve helped calm this vital funding market.