Understanding the Changing US Liquidity Landscape
The US liquidity landscape has been significantly affected by the COVID-19 pandemic. Businesses are not only facing historically low interest rates, but also the possibility of negative interest rates.
Tom Meiman, Product Line Manager for Liquidity Balances and Demand Deposit Account Services, BNY Mellon Treasury Services, and Sam Schwartzman, Head of the IMG Cash Solutions Group, BNY Mellon Markets, explore how businesses can successfully traverse the changing liquidity landscape and achieve their cash management goals in this turbulent environment.
For over ten years, treasurers and risk managers have faced the challenge of low interest rates in the US. Imposed following the 2008 global financial crisis, these low short-term rates have dominated the liquidity landscape ever since.
Although short-term rates increased somewhat after December 2015, the unprecedented volatile conditions brought by the COVID-19 pandemic caused rates to decline back to very low levels, making liquidity management more difficult than ever.
As uncertainty rose in mid-March, market players faced the rapidly changing economic and regulatory environment caused by the global pandemic. In a six-week period, over $1 trillion was moved into Government and Treasury money market funds (MMFs). T-bill and overnight Treasury repo rates subsequently became negative at times due to the significant increase in demand in such a small time frame. LIBOR rates were also greatly affected and rose dramatically in March with credit spreads widening.
Even though overnight Treasury repo rates are currently positive and LIBOR rates have declined from their extreme levels, the long-term effects of the pandemic are yet to be seen. Businesses are increasingly worried about a second wave and the effect it could have on the economy for the foreseeable future.
Even though overnight Treasury repo rates are currently positive and LIBOR rates have declined from their extreme levels, the long-term effects of the pandemic are yet to be seen.
In this uncertain and turbulent liquidity landscape where organisations continue to face historically low interest rates, what is being done? What can banks do to mitigate the impact of the new liquidity “norm” to ensure they can support their clients in executing successful cash management strategies?
In an effort to inject liquidity into the markets, the Fed took swift regulatory action, injecting $3 trillion into the US market.
Meanwhile, the Coronavirus Aid, Relief, and Economic Security (CARES) Act was passed in March, containing billions in one-time cash payments to individual Americans, increased unemployment benefits, aid for small and large businesses, and funding for state and local governments. The unprecedented $2.2 trillion economic rescue package – the largest in US history – delivered urgently-needed relief to the American economy.
Additionally, the Fed made the decision to remove the reserve requirement ratio on deposits, which stipulated that banks must set aside a percentage of their assets as cash at the Fed. While banks generally hold more than the required amount, this initiative freed up cash reserves for individual and corporate lending.
The response also included temporary changes to the supplementary leverage ratio rule (SLR). Until 31 March 2021, bank holding companies are not required to factor in federal reserve deposits and Treasury securities when calculating their total assets – which, in effect, reduces the amount of capital that they are required to hold. This was particularly useful at peak uncertainty during the pandemic thus far because it freed up bank balance sheets and provided further liquidity to the market.
The Fed introduced several other initiatives aimed at securing additional liquidity. Some of the most noteworthy programs include: the Money Market Mutual Fund Liquidity Facility (MMLF), the Primary Dealer Credit Facility (PDCF), and the Primary Market Corporate Credit Facility (PMCCF). With more program use expected and continuing purchases of Treasury and mortgage-backed securities, the Fed’s balance sheet will continue to grow.
Looking to future rates
As the impact of the COVID-19 pandemic stretches into the foreseeable future, treasurers and risk managers continue to face considerable uncertainty. So what does the future hold for short-term market rates?
The federal funds rate is expected to stay near zero. At the end of July, the Fed confirmed it was maintaining its target range of 0% to 0.25% and is expecting to maintain this range until it is “confident that the economy is on track to achieve its maximum employment and price stability goals," which will likely not occur before 2023. According to a recent survey, nearly 60% of economists believe that this target range will either remain in place or will have dropped even further by the end of 2021. However, it is important to note that, at the moment, rates are not expected to go negative.
T-bill rates began to gradually rise after the market overcame the initial volatility – but have stabilized recently. If T-bills begin to trend upwards again, their rates could be capped as banks begin to move deposits away from the Fed and into the T-bill markets in search of yield.
Elsewhere, LIBOR rates are expected to remain relatively flat for the moment. However, this expectation assumes that the market remains steady and does not experience the turbulence and uncertainty seen in March and April.
MMF yields have been on a downward trajectory since March. This is because the funds were benefiting from holding securities purchased prior to when the two Fed interest rate cuts took effect in mid-March. This lag effect has now run its course, however, most Government and Treasury money market funds are yielding at or close to zero.
It is important to note that, at the moment, rates are not expected to go negative.
Optimising operating cash
The recent turbulence in the liquidity landscape has led to a dramatic increase in bank deposits in the short-term market space. So, how can treasurers most efficiently and effectively optimise their operating cash?
Demand Deposit Accounts (DDAs) have been a favored option in cash management strategies for decades. Since they don’t bear interest and avoid direct tax obligations, they are a leading transaction accounts providing security, flexibility and cash on demand. Other popular tools include sweeps, interest bearing accounts, hybrid accounts, and netting and pooling – each used to maximise operating cash but with their own unique advantages.
Investment accounts can also be used to purchase securities, MMF positions, and the increasingly popular FICC SMP repo product.
But with an array of tools available, how do businesses decide what is right for them? Each tool provides a range of benefits, but it is critical that the treasurer or risk manager applies them carefully within a cash management strategy that takes into account their individual needs and, of course, the market landscape.
Facing the new norm
The US markets are historically accustomed to low interest rates, but the turbulent and uncertain environment of COVID-19 has brought rates close to zero once again. While the current outlook does not predict the implementation of negative rates, the economy continues to grapple with price volatility and uncertain supply and demand dynamics. It is especially prudent for businesses to plan for various eventualities, including the possibility of a negative rate.
Clients require expert support and guidance as the new realities become clearer in the coming months. Banks must educate their clients about the changing dynamics of the liquidity landscape and ensure they are forearmed with knowledge of the cash management options available. Only then will clients be best positioned to optimize their excess operating cash management strategies.
The views expressed herein are those of the authors only and may not reflect the views of BNY Mellon. This does not constitute Treasury Services advice, or any other business or legal advice, and it should not be relied upon as such.