Monday Musings: February 16, 2021

Feb 16, 2021

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Public Trust Credit Team
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Fed balance sheet normalization plan anything but normal for money markets

This morning, Bloomberg is reporting that former Federal Reserve Chair and current Treasury Secretary Janet Yellen has expressed a desire to “normalize” the U.S. Treasury’s extremely large cash stockpile held at the Fed. While the method and pace matter a great deal, such an action could potentially flood the money markets with liquidity and drive the exceedingly low short-term interest rates below zero. Treasury’s cash balance expanded from ~410$ billion at month-end in March 2020 to over $1.65 trillion at present. While the impact on the capital markets is debatable but considered to be positive, the effect on the money markets will be negative unless the Fed decides to raise the rate on Interest on Excess Reserves (IOER) from the current levels. Any action on this front will be determined during next month’s meeting of the Federal Reserve. 

Compounding the potential risk is the possibility that the Fed and other bank regulators re-impose a stringent supplementary leverage ratio methodology on banks. Since last March, regulators have allowed banks to exclude Treasuries and reserve accounts held at the Fed from the calculation. There seems to be no clear consensus on the impact of such an action, but there is some risk of large sales of Treasury securities which would expand banks’ already large cash positions. Developments related to this topic will be the focus of a great deal of hand-wringing over the coming weeks, so stay tuned.
All comments and discussion presented are purely based on opinion and assumptions, not fact. These assumptions may or may not be correct based on foreseen and unforeseen events. The information presented should not be used in making any investment decisions. This material is not a recommendation to buy, sell, implement, or change any securities or investment strategy, function, or process. Any financial and/or investment decision should be made only after considerable research, consideration, and involvement with an experienced professional engaged for the specific purpose. Past performance is not an indication of future performance. Any financial and/or investment decision may incur losses.

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