Investors put a record amount of cash in an overnight facility at the Federal Reserve on Thursday after the central bank began paying interest on the money to prevent negative interest rates from taking hold in parts of US financial markets.
The change, announced on Wednesday after the monetary policy meeting, was in response to concerns from money market funds and banks that have struggled to find positive-yielding places to invest.
Nearly 70 market participants parked $756 billion with the Fed through the reverse buyback program, according to data from the central bank’s New York branch.
That’s about $172 billion higher than the previous record earlier this week, and $235 billion more than Wednesday, when only 53 groups used the facility.
“The surge in usage shows how starved investors are for returns” in short-term debt, said Gennadiy Goldberg of TD Securities.
The Fed said it raised the RRP rate from zero to 0.05 percent to support “the smooth functioning of short-term financing markets,” one of two technical adjustments it made on Wednesday. It also increased the interest it pays on excess reserves deposited by banks with the Fed from 0.1 percent to 0.15 percent.
Partly as a result of monetary and fiscal stimulus to the US economy, cash has flowed into money market funds that invest in short-term government securities. Strong demand for those securities has at times pushed yields below zero this year and threatened the viability of the $4 trillion industry.
The rate at which investors exchange government bonds and other high-quality collateral for cash in the repo market – another major source of income for money market funds – has also declined negatively.
Wednesday’s adjustments helped lift those rates from their ultra-low levels. The Federal Funds rate, the main policy rate used by the Fed, also rose to 0.08 percent, closer to the middle of the central bank’s 0 to 0.25 percent target range, after falling earlier this year. to just 0.04 percent.
Jay Powell, the Fed chairman, expressed little concern in his post-meeting press conference about the increasing use of the RRP facility, indicating that it was working as intended.
“We think the reverse repo facility is doing what it’s supposed to do, which is to provide a floor below money market rates and keep the Federal Funds rate well within range.”
Scott Skyrm, a repo trader with Curvature Securities, said the rate adjustments announced Wednesday would help improve margin, but demand for RRP was likely to remain high. The Fed’s commitment to buy $120 billion in government debt each month to stimulate the economy continues to exacerbate the mismatch between the amount of cash looking for a home and the number of viable securities to buy.
John Canavan, an analyst at Oxford Economics, said the magnitude of the increase in RRP use on Thursday was a surprise.
“This probably isn’t the end of the uptrend, and there’s a good chance the deluge of front-end cash will push demand for RRP over $1 trillion at some point.”