credit Markets

The Fed Effect On Flows, And A $4.7 Trillion Cash Pile Suddenly Facing Negative Returns

Flow reversals and the "cost of cash".

In what’s become a Friday tradition, the Fed said it will slow the pace of Treasury buying in the coming week, this time to $7 billion per day from $8 billion previously.

This is in keeping with recent precedent. They’ve trimmed daily buying regularly since the introduction of unlimited QE in March.

The latest read on the balance sheet shows the Fed’s holdings have ballooned to $6.72 trillion. Last week’s addition was “just” $65.5 billion, the least since the Fed began to ramp up purchases in response to the crisis.

A week ago, I argued that the biggest story for markets wasn’t the rally in stocks in April (the best month since 1987, set against the worst data in history), but rather the second consecutive month of record high-grade issuance.

The mere prospect that Jerome Powell is set to put the Fed’s limitless balance sheet behind the corporate credit market was enough to tamp down spreads and pry open the doors even for junk borrowers at a time when corporate management teams are keen on raising cash to help shore up their finances amid the storm.

Indeed, there’s a strong argument to be made that the Fed helped the government avoid bailing out Boeing, by creating favorable market conditions which allowed the beleaguered national champion to tap investors for $25 billion in the sixth-largest deal on record last month.

With all of that in mind, it’s worth noting that the latest data from Lipper shows IG funds enjoyed a fourth consecutive week of inflows last week, marking a continuation of the remarkable turnaround from a truly harrowing stretch in March.

High yield funds took in $3.53 billion, Lipper said, a large sum that continues a hot steak now set to run into a seventh week.

Meanwhile, EPFR data for the week shows $16.2 billion flowing out of global equities, the most since the March crash. Another $53.5 billion moved into cash, while $11.3 billion went to bonds and $2.3 billion to gold.

“[The] cash mountain is yet to peak”, BofA said, noting that money market fund assets are up $1.2 trillion in the last 14 weeks to $4.8 trillion.

It’s worth taking a second to consider what that means at a time when markets are now pricing negative rates from the Fed.

Obviously, it’s difficult to generate any kind of return in government money funds when rates are parked at the lower bound, and the situation is scary indeed now that STIR traders seem hell-bent on cornering the Fed into cutting rates below zero.

This isn’t the first time funds have had to cope with ZIRP, but AUM is twice as large as it was for most of the post-crisis, low-rate era. Increasingly, it looks as though the industry will again be forced to waive management fees and resort to “creative” tactics to squeeze out some semblance of positive returns for investors.

The problem goes beyond rock-bottom yields on bills. “The profitability from lending in repo markets has also been reduced”, Bloomberg’s Alex Harris wrote Friday, noting that one manager she spoke to is “finding value in two-year floating rate notes” and is tapping sponsored repo. “The last resort… is stowing cash in the Fed’s overnight reverse repurchase operations at a rate of 0%”, that manager told Harris, while another mentioned that agency MBS still works, as do coupons and bonds that are near maturity, although that comes with liquidity risk – and you don’t want that if you’re a money market fund.

This is the “price you pay” for owning cash, but it looks like that turn of phrase will go from a figurative way of describing lost opportunities in riskier assets to a literal reference to negative returns on trillions parked in money market funds.

But really, why hang out in cash and wait around for the inevitable? After all, there are myriad exciting places for adventurous capital to go in a world where corporate borrowers continue to tap the market for billions, even as profits collapse into the black hole that is America’s imploding economy.

Headed into Friday, for example, at least 10 companies were on deck, an unusually high number for the last day of the week, especially for a session defined by the worst jobs report in American history. “No-deal Fridays are slowly becoming a rarity as syndicate desks and borrowers take advantage of the wide open issuance window”, Bloomberg noted.

Amusingly, the momentum looks like it’s poised to run out for LQD, the most popular IG credit ETF on the market.

Having closed below its 200-day moving average twice, and with the RSI fading, the Fed-inspired euphoria is clearly abating.

Maybe if Powell waits another week before buying, he can get in at a better price – and then bid up his own holdings to infinity.


2 comments on “The Fed Effect On Flows, And A $4.7 Trillion Cash Pile Suddenly Facing Negative Returns

  1. Gives a whole new meaning to “Don’t Fight the Fed”

  2. Dr. H,
    Does this mean yield starved money moving to risk assets?

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