NEW YORK: The Federal Reserve’s (Fed) floor for overnight funding markets is proving to be no match for the deluge of cash.

       Money-market securities ranging from Treasury bills to repurchase agreements continue to trade below 0.05% – the offering rate on the overnight (ON) reverse repo (RRP) facility, which is supposed to act like a floor for the front end.

       The Fed at its June meeting had raised the rate by five basis points to help support the smooth functioning of short-term funding markets.

       Still, usage of the tool climbed to a record US$1.136 trillion (RM4.79 trillion) on Monday, eclipsing the previous high of US$1.116 trillion (RM4.71 trillion) on Aug 18.

       Demand for the so-called RRP facility has surged as a flood of dollars threatens to overwhelm funding markets.

       That’s in part a result of the central bank’s long-standing asset purchases and drawdowns of the Treasury’s cash account, which is pushing reserves into the system.

       As a result, liquidity has been swelling, especially as the Treasury cuts supply to create more borrowing room under the debt ceiling.

       The pressure pushing down overnight rates toward zero is proving a major headache for money-market funds.

       It hampers their ability to invest profitably, and can lead to further disruptions as they begin to waive fees to avoid passing on negative rates to shareholders.

       A number of firms including Vanguard Group shut down prime money-market funds last year after struggling to cover operating costs in the low-interest-rate environment.

       “The Fed’s technical adjustment earlier this year is not a panacea for the money markets,” JPMorgan Securities strategists Teresa Ho and Alex Roever wrote in a note.

       “Supply and demand technicals remain an overarching driver of rates, and with the supply and demand gap now having grown to US$1.35 trillion (RM5.7 trillion), it’s not surprising that the Fed’s ON RRP is providing only a soft floor for money market rates.”

       The strategists predict the distortion will linger even after the Fed begins reducing asset purchases from the current level of US$120bil (RM506.5bil) per month.

       Even if the central bank were to complete tapering by August 2022, as JPMorgan expects, there may still be an additional US$850bil (RM3.6 trillion) to US$1 trillion (RM4.22 trillion) of additional liquidity injected into the financial system.

       While Treasury bill supply is expected to rebound once the debt-ceiling limit is resolved, it’s still unclear when that will happen.

       Bills maturing at the end of October and through November are yielding more than the securities surrounding those dates. — Bloomberg