Hmm. I'm getting stuck. I still don't understand why "it is wrong to draw the conclusion that money funds are using the ON RRP facility because there are no better alternative investments."
Where am I going wrong?
If there *were* better alternative investments for money funds, then we'd see:
1. Money funds holding less RRP and more securities.
2. The public holding fewer securities and more deposits.
3. Banks holding more reserves.
Is that correct?
And if there *weren't* better alternative investments for money funds, we'd see:
1. Money funds holding more RRP and fewer securities.
2. The public holding more securities and fewer deposits.
3. Banks holding fewer reserves.
"So if it were the lack of better alternatives that was stopping money funds from reducing ON RRP balances, we should see steady balances of bank reserves, or even increasing balances if banks faced the same problem."
Why would the lack of better alternatives cause steady or increasing reserves?
"In fact, banks are reducing reserve balances, while money fund ON RRP balances are expanding."
I don't understand why this isn't exactly what you'd expect if money funds were using ON RRP because there were no better alternative investments.
"Reserves pay 90 bp, ON RRP pays 80: money is moving from the higher- to the lower-interest investment."
Right, but money has to move in this direction the public is pulling out its deposits from the banking sector to buy securities from the money funds. Right?
"Conclusion: banks are reducing reserve balances because they want to, for a reason other than interest rates."
They're not reducing their reserve balances because ON RRP is causing a reserve drain out of the banking system as a whole?
"ON RRP, meanwhile, sets a floor under interest rates: it is literally the worst asset money funds can buy. Yet ON RRP deposits are increasing to record levels. Conclusion: money funds don’t have control over ON RRP balances."
If money funds had better investments, what prevents them from moving out of RRP?
"Banks are contracting reserves because they can, money funds are expanding overnight repo because they have to."
I'm not convinced. But like I said, I might be missing something.
Perhaps it is angels dancing on the head of a pin. But when I say "it is wrong to draw the conclusion that money funds are using the ON RRP facility because there are no better alternative investments," my issue is with the word "because."
This is very interesting. Why would banks willingly reduce reserves? As reserves attract penalty from SLR, I assume banks have more profitable uses for their balance sheet.
The H8 table from the Fed suggests the diversion from reserves since end-2021 has been fairly equally distributed among additional Treasuries assets, more real estate (split 55% commercial, 45% resi) and 'Other loans not elsewhere classified'. Sounds like banks have decided to be banks again.
At the same time, banks have increased loans to the public (reserves decreased but replaced with other assets) and the banks deposits created have been destroyed to go in MMFs->ONRRP. It is as if banks lend to the public for the public to put it in ONRRP
I mean that at a systemic level, money funds in aggregate are not able to turn away inflows and so ON RRP continues to rise. It may or may not look that way from any one fund's point of view, but I believe the conclusion is correct.
Hmm. I'm getting stuck. I still don't understand why "it is wrong to draw the conclusion that money funds are using the ON RRP facility because there are no better alternative investments."
Where am I going wrong?
If there *were* better alternative investments for money funds, then we'd see:
1. Money funds holding less RRP and more securities.
2. The public holding fewer securities and more deposits.
3. Banks holding more reserves.
Is that correct?
And if there *weren't* better alternative investments for money funds, we'd see:
1. Money funds holding more RRP and fewer securities.
2. The public holding more securities and fewer deposits.
3. Banks holding fewer reserves.
"So if it were the lack of better alternatives that was stopping money funds from reducing ON RRP balances, we should see steady balances of bank reserves, or even increasing balances if banks faced the same problem."
Why would the lack of better alternatives cause steady or increasing reserves?
"In fact, banks are reducing reserve balances, while money fund ON RRP balances are expanding."
I don't understand why this isn't exactly what you'd expect if money funds were using ON RRP because there were no better alternative investments.
"Reserves pay 90 bp, ON RRP pays 80: money is moving from the higher- to the lower-interest investment."
Right, but money has to move in this direction the public is pulling out its deposits from the banking sector to buy securities from the money funds. Right?
"Conclusion: banks are reducing reserve balances because they want to, for a reason other than interest rates."
They're not reducing their reserve balances because ON RRP is causing a reserve drain out of the banking system as a whole?
"ON RRP, meanwhile, sets a floor under interest rates: it is literally the worst asset money funds can buy. Yet ON RRP deposits are increasing to record levels. Conclusion: money funds don’t have control over ON RRP balances."
If money funds had better investments, what prevents them from moving out of RRP?
"Banks are contracting reserves because they can, money funds are expanding overnight repo because they have to."
I'm not convinced. But like I said, I might be missing something.
Perhaps it is angels dancing on the head of a pin. But when I say "it is wrong to draw the conclusion that money funds are using the ON RRP facility because there are no better alternative investments," my issue is with the word "because."
This is very interesting. Why would banks willingly reduce reserves? As reserves attract penalty from SLR, I assume banks have more profitable uses for their balance sheet.
Well yes, that is the next question. My thought was that they are positioning ahead of the Fed beginning to contract next week.
The H8 table from the Fed suggests the diversion from reserves since end-2021 has been fairly equally distributed among additional Treasuries assets, more real estate (split 55% commercial, 45% resi) and 'Other loans not elsewhere classified'. Sounds like banks have decided to be banks again.
At the same time, banks have increased loans to the public (reserves decreased but replaced with other assets) and the banks deposits created have been destroyed to go in MMFs->ONRRP. It is as if banks lend to the public for the public to put it in ONRRP
When you put it that way, it sounds like a liquidity trap.
Also, could it be that there is one '+ Reserves' missing in line (3) in the Banks' T account? Many thanks for your precious precious work!
Thanks, fixed!
Many thanks, very interesting.
What is the reason for MMMFs to increase ONRRP then? What do you suggest when you say that they have 'no control' over it? Many thanks in advance!
I mean that at a systemic level, money funds in aggregate are not able to turn away inflows and so ON RRP continues to rise. It may or may not look that way from any one fund's point of view, but I believe the conclusion is correct.