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?
Regulatory action
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.
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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.
US stock markets ended mostly lower on Wednesday following the release of a policy statement from the US Federal Reserve, with futures pointing towards a stock sell-off on Thursday.
The Fed announced that US interest rates would remain between 0% and 0.25% and indicated that they would likely remain that way until 2023 at the earliest. No additional stimulus plans were announced, though Federal Reserve Chair Jerome Powell pledged that the Fed “will not lose sight of the millions of Americans that remain out of work.”
Investors who had anticipated new stimulus measures were left disappointed by the statement. US stocks fell following Powell’s press conference, with only the Dow closing in the green. Thursday morning saw US futures skewing sharply negative; Dow Jones futures were down 1.3%, S&P 500 futures were down 1.6%, and Nasdaq futures were down 1.7%.
The negative sentiment had a ripple effect in European markets, which opened in the red on Thursday. The FTSE fell by 1%, the DAX 30 by 1.4% and the CAC by 1.3% in early trading.
Asian stocks also saw an overnight sell-off, though not so sharply. Japan’s Nikkei index fell by 0.6%, while South Korea’s KOSPI shed 1.2%. The Hong Kong Hang Seng suffered most, sliding by 1.7%., while mainland Chinese indexes were relatively unaffected; the Shanghai Composite slipped 0.4% and the Shenzen Component remained flat.
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In addition to the absence of newly proposed stimulus measures, analysts noted that investors were likely spooked by the news that two officials on the Federal Open Market Committee voted against the move to keep the Fed’s inflation benchmark rate unchanged.
Connor Campbell, financial analyst at SpreadEx, said that the “no” votes indicated “a brewing hawk camp in an FOMC full of doves.”
This is the warning from Nigel Green, deVere Group CEO and founder, as the world’s largest cryptocurrency jumped more than 4% on comments made by Jerome Powell that the Fed is investing a significant amount into digital currency development.
Mr Green states: “This is further evidence that not only all major banks, government agencies, plus most sectors including tech, entertainment and real estate, are piling into cryptocurrencies – but that central banks are too.
“The previously sceptical Fed has not, until now, admitted how rapidly digital currencies could become a systemic risk to the US dollar’s status as global reserve currency.
“This is a major step in underscoring – especially to those backward-looking traditionalists – that, whether they like it or not, digital global currencies are not only the future of money, they are increasingly the present too.”
He continues: “The development from the Fed comes following news that China – a communist state and the US’s main economic rival – is currently developing what has been described as an all-powerful cryptocurrency. It could be ready this year and be the world’s sovereign digital currency.”
Mr Green goes on to say: “Whilst there will be minor peaks and troughs – as in all markets - I predict the overall trajectory of Bitcoin to remain upward for the next few months.
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“Besides increasing institutional awareness and development, other major factors driving its price advance will be coronavirus.
“Bitcoin’s price is likely to continue to jump until the coronavirus peaks because of the growing consensus that the digital currency is a safe-haven asset.
“Its status comes from the fact that it is a store of value, scarce, perceived as being resistant to inflation, and a hedge against turmoil in traditional markets.”
He adds: “Another major price driver will be the next halving event.
“The code for mining Bitcoin halves around every four years and the next one is set for May this year. When the code halves, miners receive 50% fewer coins every few minutes. History shows that there is typically a considerable Bitcoin surge resulting from halving events.”
The deVere CEO concludes: “The Fed’s public acknowledgement of cryptocurrencies was important, but most investors have already known that major central banks around the world are developing crypto.
“As such, the main drivers for Bitcoin price for the next few months will remain coronavirus and May’s having event.”
(Source: deVere Group)
Below Dan North, Chief Economist at Euler Hermes North America, lists several updates and thoughts on the latest matter surrounding the US federal reserve.
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- A rate increase is a lock this week.
- We have been saying there will be 2-3 hikes in 2018, but now there seems to be pressure towards 3-4.
- We expect that the dreaded “dot-plot” the worst communications device ever, will also show a bit more of a lean to 4 hikes next year as recent economic data has been solid, and prospects for tax reform appear good (but we’re not there yet).
- The solid data will likely lead to a slight increase in the Fed’s GDP forecasts.
- Many wonder why the Fed is raising rates when we are still in relatively slow growth with no inflation. But it’s not about inflation today, it’s about inflation tomorrow since monetary policy acts with a lag of 3-5 quarters. And there is inflation – it’s just that it’s in assets like stocks, not consumer prices. Fed officials have expressed concerned about the risk of asset prices being overvalued.
- There is a problem though, Houston. The yield curve is flattening, and it may be because of the Fed. Clearly markets expect the Fed to keep driving the overnight rate up, and that could be pushing up the short end of the curve. And if you believe Fed actions will hold down inflation that could be pushing down the long end. That’s not a good sign for growth.
- Let’s not forget, when the Fed raises rates, it’s trying to slow the economy, and it works.
- Expectations are that there will be little change in posture next year under Powell’s command since he has never dissented as a Board member since 2012. He gave a relatively dovish testimony at his Senate hearing, suggesting he would basically be following in Yellen’s footsteps of raising rates gradually. But he also cautioned, as has Yellen, that hiking too slowly could cause inflation to overheat and force the Fed to hike rates faster.
- Interestingly Powell indicated that banking regulations implemented after the financial crisis were strong enough, but that it was also time to make the rules more efficient and less burdensome. “"We want regulations to be the most intense, the most stringent for the very largest, most complex institutions and want it to decrease in intensity and stringency as we move down through the regional banks and the community banks,"” Regional banks have been caught up in regulations designed for the larger banks, hampering loan growth. Relief for them could help the economy, and their stocks have rallied sharply since his testimony.
- Of course it’s Yellen’s last press conference. Will we hear a farewell, or some fond reminiscences?
Donald Trump is set to make a decision on the Chair of the Federal Reserve by Thursday this week. This decision will shape a big part of the US President’s economic legacy in the job.
The current chair of the Federal Reserve was appointed by President Obama in 2014 and is the first woman to hold the position.
Below Finance Monthly hears from a few expert sources on their thoughts surrounding the future prospects and overall impact of the appointment of a new US Fed Chief.
Joel Kruger, Currency Strategist, LMAX Exchange:
We worry investors could be setting themselves up for a letdown on this expectation the appointment of Jerome Powell as the next Fed Chair will generate a sustainable rally in risk assets. There is a danger associated with what has become a fixation on 'one dimensional role designation.' Central bankers should be neither inherently hawkish or dovish. The Fed's responsibility is to ensure it works in the best way possible to achieve its goals of maximum employment and price stability.
Considering where we're at in the cycle, there's simply little room for dovish central banking into 2018, much in the same way there was little room for hawkish central banking back in 2008, at the onset of the financial markets crisis. We believe we've reached the point where dovish leanings will no longer pair well with effective monetary policy, given an economic outlook contending with the very nasty combination of full employment, financial stability risk (from overinflated stocks), and the threat of rising inflation. We would also add that the prospect of Powell as the next Fed Chair is one that has been played out ad nauseam. This alone leaves risk assets vulnerable and exposed to a sell the fact reaction, albeit after what is likely to be an initial wave of euphoria.
Mihir Kapadia CEO and Founder, Sun Global Investments:
After months of speculation, President Donald Trump’s nominee for the Federal Reserve chairman seems likely to be Federal Reserve governor Jerome Powell. A former investment banker with Treasury experience during the Bush administration, Powell looks to be a reliable choice for the role. The markets have reacted positively to the suggestion that Powell is the frontrunner in recent weeks following the President’s interviews with each of the candidates.
However, Powell’s succession to the Fed chair is not necessarily secure. Other candidates include former Fed governor Kevin Warsh, seen as a more hawkish alternative to the polices of Yellen ad Stanford Professor John Taylor who would definitely be seen as more hawkish. Gary Cohn, Trump’s economic adviser, was also touted for the job, although the President has indicated his preference for Cohn to remain in the White House. Furthermore, current Fed chair Janet Yellen still remains a viable possibility.
Trump’s relationship with Yellen has been tricky to define. On the campaign trail, Trump was highly critical of Yellen and her tenure, and accusing her of being political. However, his stance has softened considerably since becoming President, praising her both personally and professionally, leading some to believe that he could yet choose her for another term. Of all the candidates, Jerome Powell represents a pragmatic compromise for the President – he represents a break from the past and a shift towards Trump’s administration whilst representing continuity as his policies are unlikely to differ substantially from Yellen’s. Whatever the President’s decision, the Fed chair will play a powerful role in shaping the economic identity of Trump’s America.
We would also love to hear more of Your Thoughts on this, so feel free to comment below and tell us what you think!
