Flood of money in the US financial system is putting pressure on the Fed’s key interest rate

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According to analysts, the Federal Reserve may need to recalibrate its political toolkit as a flood of cash flowing through the U.S. financial system has made it difficult for the central bank to maintain tight control over its policy rate.

Short-term interest rates have fallen to all-time lows since the beginning of this year as cash-flush financial institutions compete for lending in low-risk vehicles such as near-term or so-called US Treasuries, repurchase agreements.

“Obviously there is a huge insatiable demand. . . and it’s like playing with musical chairs when it comes to who can find supply first, ”said Teresa Ho, a strategist at JPMorgan who estimates there will be a 751 supply-demand gap in funding markets as of April Billion dollars there.

The increase in liquidity is due in part to the Fed’s purchase program, in which it purchases US $ 120 billion in US Treasuries every month. Bank deposits being converted into money market funds, as well as the Treasury Department’s plans to run down its record stash of cash and withdraw funds in connection with the stimulus package recently passed by Congress, have also added to reserve balances.

At the same time, the department has withdrawn from issuing treasury bills due within a year or less – which has reduced the supply of essential assets for holding cash.

Large amounts of cash have returned to the Fed, and demand for the central bank’s reverse repo facility, which financial firms can use to temporarily park, has increased. Daily usage rose to its highest level since 2017 last week, reaching $ 369 billion on Friday.

The $ billion line chart showing the cash glut is fueling demand for the Fed's reverse repo facility

These factors have pushed the Fed’s key interest rate down to a level that has been increasingly scrutinized by analysts and investors.

The key interest rate is 0.06 percent, which is well below the middle of the central bank’s target rate of 0 to 0.25 percent. A sustained tick of less than 0.05 percent could be enough for the Fed to take action, said Kelcie Gerson, a strategist at Morgan Stanley.

The Fed already has extended access to the reverse repo program and Limits lifted In terms of the amount of cash, financial firms can park anywhere between $ 30 billion and $ 80 billion with the central bank to divert liquidity from the system and slow the downward movement in short-term interest rates.

According to analysts, a next step could be to increase the interest that the Fed pays banks on reserves they hold at the central bank. Another reason is the increase in the interest rate that the Fed pays in its reverse repo program.

“The Fed is vigilant on this issue,” added Thomas Simons, Jefferies economist. “You don’t want to let it get out of hand.”



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