There is a crowded trade, and it is in the most innocuous corner of the market : The Money Market.
The total financial assets held in Money Market Funds (MMFs) has doubled during the last decade and is at a record $5.45 trillion now.
MMFs, especially Govt MMFs (GMMFs), usually hold short-term debt securities such as T-Bills, T-Notes or T-Bonds. But that staid mix of T’s changed to include a few R’s after the Fed created the overnight reverse repo purchase (ON RRP) in 2013 and widened the scope of the participants to include MMFs; and since then MMF participation in ON RRPs, especially since last year, are on a tear (indeed why lend to a commercial bank for a lower interest rate when you could lend to the Fed for a higher rate!) On the ON RRP, the Fed is obligated to pay 5 bps more than the lower end of the Fed Funds Rate (with the Fed Funds Rate currently at 5% to 5.25%, the ON RRP yields 5.05%!)
When you look at any GMMF factsheet today, you will notice a heavy tilt towards Repo Purchases (You could think of the Fed here as a seller of the repo and the MMF – and effectively you as the investor – as the purchaser of the repo)
This heavy skew towards UST repos among MMFs is a recent phenomenon and has a couple of catalysts:
(1) the rapid interest rate liftoff last year may have led to a rotation out of T-Bills and Notes, which with increased price risks were skating on thin ice, into Repo Purchases which in contrast provided terra firma.
(2) The SVB debacle earlier this year fuelled an exodus of investors from bank deposits into MMFs, and from there on into Repo Purchases.
MMFs usually attract record inflows when there are spells of de-stability as investors flock to the safety of USTs (check out the 3 peaks in Q1 2002, Q4 2008 and Q2 2023). But this time around the crowding into MMFs is due to the allure of the Repo Purchases. And the Fed is enabling this by keeping the ON RRP policy active for longer than required (creating another horseman, in its inflation fight, to choke bank credit).
Recent data indicates two trends:
(1) that the ON RRP liabilities on the Fed’s balance-sheet has now declined every week since Mar 22, 2023. This is possibly due to MMFs rotating out from ON RRPs and back into T-Bills.
(2) GMMFs are seeing retail outflows since May 2023.
Are GMMFs risky investments? Not really. The usual risks exist but in mild forms: there was a sliver of a credit risk this year when the US ran another season of the Debt Ceiling drama.
But those retail outflows will eventually find their way into commercial banks and could boost lending. In that context, it will be interesting to see how long the Fed will keep the ON RRP window open to MMFs. Some restrictions were introduced by the Fed Bank of New York in April 2023; but in the absence of any clear signals of a policy roll-back, the MMF gravy train chugs along merrily. On shiny rails that are the Fed-sponsored ON RRPs.
