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Debt ceiling fight pushes money market funds to brink

US Treasury bonds updates

The supply of the safest US government bonds has been cut this month after federal spending limits were reinstated, driving prices higher and reigniting problems for the money market fund industry — which has already been bailed out by the Federal Reserve once this year.

Treasury bills — US bonds which mature in a year or less — were already scant this year after the US lengthened the average duration of its new debt issues. Supply then took another hit after Congress failed to pass legislation in July that would have allowed the Treasury department to issue new debt — known as raising the debt ceiling.

Analysts estimate issuance of new Treasury bills has been cut by roughly $900bn so far this year. That limited supply has driven prices higher and yields — the premium investors are paid to hold the debt — down to levels just above zero.

When some yields turned negative in May, the Fed intervened to put a floor under those rates. But the worsening supply crunch is drastic enough that rates are heading back towards zero despite the Fed’s support.

“The Fed facility in its capacity now is helpful, but we’re starting to see it running out of gas,” said Tom Simons, money market economist at Jefferies.

Rock-bottom yields cause problems for money market funds, a $4.4tn industry that relies heavily on short-dated debt, erasing their profits or forcing them to close their doors to new investors. Money market funds are a linchpin in the global financial system because they are used by investors as a safe place to store cash for short periods.

“Money funds are having trouble making ends meet because of these very low rates. It’s not exactly a conducive environment to be a money-market fund unfortunately. As if zero interest rates weren’t enough, this is just piling on,” said Gennadiy Goldberg, senior US rates strategist at TD Securities.

That dynamic will only get worse in the next month, said Goldberg. He does not expect the spending limits to be lifted before the end of October at least. 

The US debt ceiling has been subject to partisan brinkmanship in recent years. Although Republicans and Democrats in Congress have come to agreements to suspend those limits in the past, investors believe negotiations will go down to the wire. The Treasury department is not expected to run out of money until late October or early November.

After the decline in supply earlier this year drove some short-term rates negative, the Fed backstopped the market by paying interest on money placed in its Overnight Reverse Repo Facility. The facility provides money market funds with an alternative place to park cash, bolstering those short-term interest rates. 

The problem is that the RRP facility is now consistently being used at record levels, and is approaching the limits put on its usage by the Fed. 

“What that suggests — because the fed funds market is limited in terms of its participants — is that they’re getting up to their counterparty limit with the overnight reverse facility. So if they’re getting up to their counterparty limit, it stands to reason others are probably getting up to their counterparty limit as well, since we continue to see record highs on a pretty routine basis,” said Simons.

The Fed could ultimately raise the counterparty limits on the facility, which could relieve some pressure on the market, an option it signalled it was open to in the minutes from its July policymaking meeting. But because of pandemic-related monetary and fiscal stimulus, there is still an enormous amount of money in the economy chasing too few investments. That is likely to keep yields on bills low and money market funds under pressure.

“That poor market is stuck between a rock and a hard place. There is just nowhere to go,” said Goldberg.

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