U.S. money market funds flooded with more than $440 billion, safety in doubt as debt ceiling looms

1. Much money has been poured into U.S. money market funds. Some investors believe they are safe and have higher returns than the interest rates banks pay. However, as the U.S. debt ceiling approaches, the funds face the risk of increased volatility and a surge in redemptions.

2. The approach of the X-day of the U.S. debt ceiling may lead to the default of U.S. debt, which will intensify the redemption pressure on money market funds investing in U.S. treasury bonds and increase the pressure on small U.S. banks to survive.

3. A large amount of cash flowing into U.S. money market funds means the Fed's liquidity flows back to itself in disguise. This may lead to a decline in bank reserves, especially for small banks, whose resources may be below the minimum sufficient level.

On Monday, according to data from data provider EPFR quoted by the media, since the collapse of Silicon Valley Bank in early March, U.S. money market funds (MMF) have received a considerable inflow of more than 440 billion U.S. dollars.

The influx of these deposits is large because money market funds are safe and return far more than the interest rates paid by banks. However, as the X-day of the U.S. debt ceiling approaches, these deposits may be "just out of the tiger's mouth and into the wolf's den again."

The analysis pointed out that, on the one hand, the "Sword of Damocles" of U.S. debt default hangs high. Money market funds investing in U.S. treasury bonds may face increased volatility, and redemption pressure may surge. On the other hand, part of the deposits will flow back to the Fed's overnight reverse repurchase facility (RRP), which will increase the pressure on small U.S. banks to survive.

As the X-day of the U.S. debt ceiling is approaching, MMFs face the risk of increased volatility and a surge in redemption scale.

As the total debt of the United States exceeds the upper limit, the farce of the debt ceiling that will never be "renewed" is staged again. In January this year, the scale of the U.S. government's debt reached the legal limit of 31.4 trillion U.S. dollars. The U.S. Treasury Department began unconventional measures to avoid a government default temporarily... If Congress does not raise or suspend the debt limit, the United States will face a substantial default on its debt once the Treasury Department exhausts its extraordinary measures (X-day).

To make matters worse, this class of Republicans is more persistent. This bipartisan "battle" is likely to be more intense than previous ones, with the deadlock between Democrats and Republicans looking unlikely to be resolved before the looming threat of a default in late summer.

When X-day comes, Goldman Sachs expects it to be in June or July, and U.S. Treasury Secretary Yellen expects it to be in July. Investors have begun to avoid bills due in late July and early August. Experts generally believe that the U.S. government may run out of cash during this period, and demand for three-month government bond auctions this week has also been poor.

At the same time, the surge of cash flowing into MMF also means that the use of RRP has increased. The previous article analyzed how the Fed's liquidity flowed back to itself in disguise.

MMF only invests in tools such as U.S. Treasury bills and repurchase agreements. Due to the relative shortage of short-term bonds, many funds are used in RRP to obtain a return of up to 4.8%. Currently, the daily use of the Fed's reverse repurchase tools is about 2.3 trillion dollars.

The balance of monetary funds flows into RRP, and bank reserves will decline accordingly. Overlaying Q.T. will accelerate the decline of bank reserves, and soon bank reserves, tiny banks, will be lower than the desired level of resources.

Barclays estimates that if there is no change in Q.T., bank reserves could fall below $2.6 trillion by August, the lowest level since the summer of 2020. Small banks' reserves will fall below the minimum sufficient level, and more small banks will fail.

If debt-ceiling concerns dampen demand from money market funds to buy government bonds, that could lead to more money pouring into the RRP, whose ballooning size will further pressure the banking sector.

Faced with this pressure, will the Fed act? Previous analysis pointed out that restricting RRP affects policy easing, but the loose money will not flow to banks that are short of cash.

Barclays believes there is no good reason for the Fed to squeeze funds out of the RRP by adjusting policy. Cutting the reverse repurchase rate will have little effect. On the contrary, it will disrupt the function of the repo market, and at the same time, funds will eventually flow into large banks that are not short of money rather than small banks that are short of cash.

JPMorgan Chase pointed out that lowering the RRP ceiling will reduce interest rates under the market mechanism. The short-term borrowing costs of both government and non-government issuers will decrease.