Investors’ use of Fed overnight facility halves from peak

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Use of a Federal Reserve facility for storing cash has halved from its peak as money market funds plough their excess funds into US government debt instead.

Investors on Friday put $1.28tn into the Fed’s overnight reverse repo facility (RRP), where cash is stored risk-free for a short period for a generous return. The total was close to the lowest level in two years, half of its $2.6tn peak and a drop of more than 40 per cent since May.

Until this year the record daily inflows of more than $2tn into the RRP were considered a sign of market uncertainty, implying that US money market funds that invest in government debt preferred the safety of the Fed over the volatility of bonds.

The facility was established permanently in 2014, and is designed to suck up excess cash in the financial system.

However, the incentives for investors have flipped in recent months, driven by data that point to a resilient US economy. That has forced traders to rethink their views on how long the Fed will keep interest rates elevated to curb inflation.

As a result last week tumbling bond prices pushed yields on benchmark 10-year Treasuries to a 16-year high of nearly 5 per cent.

Higher yields have increased the attractiveness to investors of money market mutual funds, particularly as rates from competing products such as bank deposits have failed to keep pace with interest rate moves.

A record $5.7tn currently sits in US money market funds and the vast bulk of the inflows, worth $64bn, flowed into government funds, according to weekly data released on Thursday.

Since June, the Treasury has also flooded the market with new paper, encouraging funds to shift out of the RRP, as the government has worked to replenish its coffers after Congress agreed to raise the US debt ceiling.

While moves were far less dramatic for the shorter-dated notes that act as an alternative to use of the RRP, yields on six-month bills edged up to 5.59 per cent, their highest in more than two decades, and almost a full percentage point above their levels at the start of this year.

Short-term paper typically reflects current borrowing costs while yields on longer-term notes are a measure of investor expectations for future levels.

Use of the RRP can become volatile around the end of the quarter as users move money around to help flatter their performance.