I’m often asked why money market yields are so low today - even lower than they were a few months ago. My response generally begins with overnight repurchase agreements, or repo, which impact the price of term securities in the money market space.
Over the past few weeks, overnight repo has been trading in the low single digits. And since the end of the US tax season in April, we have seen a steady decline in repo rates, with overnight repos recently trading in the 0.01% to 0.03% range.1 Below are some reasons why.
What is keeping repo rates low?
1. A sharp reduction in bill supply along with lower bill yields. The federal government had a budget surplus of $117 billion in June, a dramatic shift from $60 billion in deficits recorded in June 2012. The budget surplus is attributed in part to a 25% drop in federal spending from last year. Additionally, Fannie Mae and Freddie Mac issued large dividend payments to the US Treasury, which increased Treasury cash balances. Many US economists now expect the deficit for fiscal 2013 to narrow to $650 billion, a dramatic decline from the $1.089 trillion deficit the nation had in 2012. Given the improving federal budget outlook, we expect the Treasury to start reducing bill and coupon issuance.2
2. An increase in cash in the front end of the yield curve. As part of June’s massive US bonds sell-off, cash moved into money markets funds or other front-end instruments, including Treasury bills and overnight repos. For example, money fund assets under management have increased by more than $20 billion since mid-June.3 These flows into the short-term market are also pushing repo rates lower.
3. The Federal Reserve’s asset purchase program is moving collateral from the market and onto the Fed’s balance sheet. Excess reserves have been steadily increasing since the beginning of this year, going up by half a trillion dollars. Excess reserves are currently close to $2 trillion.4 Overnight repo rates tend to be inversely related to excess reserves, and therefore are decreasing.
With lower repo rates hovering near the front-end of the yield curve, market participants are searching for other short-dated products, such as certificates of deposit, commercial paper and variable-rate demand notes. Such short-dated products add additional yield, pushing rates down across the curve – thereby causing the overall money market curve to continue to flatten. For example, the 3-month US dollar LIBOR rate has fallen to 0.26% in July from 0.36% in September 2012.2
Looking ahead
Markets are anticipating a reduction in the Fed’s asset purchases, commonly called “tapering,” in the fourth quarter of 2013. As the Fed begins to reduce its amount of purchases, we believe the move may help ease the pressure on repo rates and short-term markets more broadly.
1 Source: Invesco, July 22, 2013
2 Source: Bloomberg L.P., July 22, 2013
3 Source: ICI, July 22, 2013
4 Source: Federal Reserve, July 22, 2013
Important information
Libor is the world’s most widely followed benchmark for short-term interest rates. Fixed daily, the Libor is the interest rate at which banks in the London interbank market can borrow overnight funds from one another. It serves as a base when determining interest rates for corporations and other large borrowers.
Past performance is no guarantee of future results.
Treasury securities are backed by the full faith and credit of the US government as to the timely payment of principal and interest.
Obligations issued by US Government agencies and instrumentalities may receive varying levels of support from the government, which could affect the fund’s ability to recover should they default.
If the seller of a repurchase agreement defaults on its obligation or declares bankruptcy, delays in selling the securities underlying the repurchase agreement may be experienced, resulting in losses.
Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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