Jeff Snider would argue a premium is being paid for scarce collateral and UST’s etc are simply balance sheet tools these days. I recommend Jeff’s work as he looks at money matters more from the collateral side rather than the cash side. His writing can explain far better than I can. See Old work at Alhambra Investments. Now at Macro Plus Insider and has written for years at Real Clear markets. Thanks again Daniel for your work.
I think it must be right that a premium is being paid for scarce collateral. And Treasuries are balance sheet tools, but is that a simple thing or not?
Based on conversations I've had following this post, I believe there is a big short interest in bonds. Those shorts are sourcing securities in the repo market, and accepting concessionary rates on their cash in order to stay in their positions.
I am not comfortable saying this is without monetary impact. But neither am I convinced by a collateral supply argument a la Manmohan Singh. Rather disappointingly, I am left with "wait and see."
Very nice post, Daniel. I’ve been looking into this too, and have a few thoughts:
- The market participants who could possibly benefit from the arbitrage are probably balance-sheet constrained (banks and dealers). We can see this by banks shedding deposits to MMFs and dealers’ constraint via (deteriorating) market liquidity.
- With this, the rate “gap” between funding markets and ON RRP take longer to close following a hike. Can see this in 1-month bill/ON RRP spread which the past three hikes have taken roughly 20 days to recover; MMFs (and other cash investors) rebalance their portfolio from Bills to ON RRP over this time. This is the main mechanism right now w/ bloated balance sheets per above.
- Participants without Fed access (asset managers, pensions), are a bit more agnostic between bills and MMFs given the fees/expenses of MMFs, but I think the recent growth of ON RRP speak to more rotation out of bills and into MMFs as well (which then deposit in ON RRP).
Still thinking through impacts of QT...more to come...
I don't have a better answer than yours. I have trouble squaring it with the Fed's saying they think ON RRP should come down first as balance sheet contraction gets underway. I do observe that the H.8 report shows banks are showing a notable increase in the liability category that is recorded as "Borrowing". Are they pushing deposits into MMFs and then borrowing cheap in the repo market?
Hmm that is very interesting and hadn’t noticed the h.8. I’d be confused if that’s what they were doing given a) it wouldn’t give them any balance sheet room and b) repo rates are much higher than deposit rates right now, so wouldn’t be economical from my intuition.
Re: Fed, I think that’s more messaging and trying to calm markets ahead of QT. The fact is, they don’t control how QT will be funded out of. That’s a Treasury decision. Only if Treasury issues more bills relative to coupons (and levered investors purchase coupons on o/n repo) would there be a smooth drain of ON RRP. But as we’ve seen ON RRP is growing, suggesting to me that it’s increasingly becoming the instrument of choice for gov MMFs.
This is all a very confusing picture that I’m still having trouble getting my arms around
I’m not sure I understand the point - MMMFs can’t lever by regulation and thus, they’re not borrowers in the overnight market but instead they’re lenders. Did I misinterpreted something?
Ah. I didn't know that. Thanks. That makes sense given that they have to issue "shares" instead of deposits.
So the way MMMFs usually "soak up" funds is by pulling deposits away from other depository institutions rather than by borrowing overnight? Is that right?
If so, here's a reworked version of my last question:
How much interest are MMMFs paying on their shares? How does it compare to interest on other forms of deposits? How does it compare to the market rate for overnight borrowing? How does it compare to the ON RRP rate?
Functionally, it sounds like the MMMFs are still doing the equivalent of levering. But they're calling their deposit liabilities "equity shares" in order to get away with it.
Gotcha, makes sense (and wasn't trying to be dense). All very good questions. Yes, MMFs attract funds in two main ways from my point of view: ability to offer higher returns than normal deposits, and because banks will push their large institutional depositors into their MMF products.
MMFs offering rates vary by the market, a function of their management fees, expense ratios (overhead costs) as well as money market rates. Right now, the interest they offer to investors is higher than deposits given low deposit betas of the banks w/ bloated balance sheets (remember, banks don't want deposits right now, so they push to their MMF products off their balance sheet - thus, banks have NO incentive to raise deposit rates to attract deposits. Brief caveat is that this is the banking sector as a whole, there are individual banks that want deposits and will pay for them).
Think of the rate that MMFs offer clients as a blend of all of the products they invest in, so they are very much contingent on what market funding rates are. It also depends on what type of MMF they are - prime can invest in riskier instruments like CP, but government funds can only invest in govies or o/n repo backed by them (i.e. tri-party). But they will certainly be paying *less* than the rates on money markets given they will net out their overhead costs as discussed above.
I'm not sure I agree that they are actually levering. Look at their capital structure: their liabilities are not credit instruments really. They're equity shares. Its entirely capital, not leverage. If you're trying to make a point that they're collecting a spread between money market rates and their investors/depositors, then I agree - there is some sort of intermediation going on here for sure. But in a balance sheet perspective, I wouldn't think of this as leverage.
Jeff Snider would argue a premium is being paid for scarce collateral and UST’s etc are simply balance sheet tools these days. I recommend Jeff’s work as he looks at money matters more from the collateral side rather than the cash side. His writing can explain far better than I can. See Old work at Alhambra Investments. Now at Macro Plus Insider and has written for years at Real Clear markets. Thanks again Daniel for your work.
I think it must be right that a premium is being paid for scarce collateral. And Treasuries are balance sheet tools, but is that a simple thing or not?
Based on conversations I've had following this post, I believe there is a big short interest in bonds. Those shorts are sourcing securities in the repo market, and accepting concessionary rates on their cash in order to stay in their positions.
I am not comfortable saying this is without monetary impact. But neither am I convinced by a collateral supply argument a la Manmohan Singh. Rather disappointingly, I am left with "wait and see."
Very nice post, Daniel. I’ve been looking into this too, and have a few thoughts:
- The market participants who could possibly benefit from the arbitrage are probably balance-sheet constrained (banks and dealers). We can see this by banks shedding deposits to MMFs and dealers’ constraint via (deteriorating) market liquidity.
- With this, the rate “gap” between funding markets and ON RRP take longer to close following a hike. Can see this in 1-month bill/ON RRP spread which the past three hikes have taken roughly 20 days to recover; MMFs (and other cash investors) rebalance their portfolio from Bills to ON RRP over this time. This is the main mechanism right now w/ bloated balance sheets per above.
- Participants without Fed access (asset managers, pensions), are a bit more agnostic between bills and MMFs given the fees/expenses of MMFs, but I think the recent growth of ON RRP speak to more rotation out of bills and into MMFs as well (which then deposit in ON RRP).
Still thinking through impacts of QT...more to come...
Is it clear to you why banks are continuing to shed deposits?
I think some continues to be balance sheet/SLR constraints. That’s my prior at least. How’re you thinking about this?
I do think it’s very idiosyncratic though.
I don't have a better answer than yours. I have trouble squaring it with the Fed's saying they think ON RRP should come down first as balance sheet contraction gets underway. I do observe that the H.8 report shows banks are showing a notable increase in the liability category that is recorded as "Borrowing". Are they pushing deposits into MMFs and then borrowing cheap in the repo market?
Hmm that is very interesting and hadn’t noticed the h.8. I’d be confused if that’s what they were doing given a) it wouldn’t give them any balance sheet room and b) repo rates are much higher than deposit rates right now, so wouldn’t be economical from my intuition.
Re: Fed, I think that’s more messaging and trying to calm markets ahead of QT. The fact is, they don’t control how QT will be funded out of. That’s a Treasury decision. Only if Treasury issues more bills relative to coupons (and levered investors purchase coupons on o/n repo) would there be a smooth drain of ON RRP. But as we’ve seen ON RRP is growing, suggesting to me that it’s increasingly becoming the instrument of choice for gov MMFs.
This is all a very confusing picture that I’m still having trouble getting my arms around
Hmm.
Is there something preventing money-market mutual funds from expanding their balance sheets to do the arbitrage?
Is there a reason why depositors wouldn't trust their money with MMMFs right now? That would prevent the MMMFs from doing the arbitrage.
How much interest are MMMFs, in particular, paying to borrow overnight? Is it higher than the market rates? Is it higher than the ON RRP rate?
I’m not sure I understand the point - MMMFs can’t lever by regulation and thus, they’re not borrowers in the overnight market but instead they’re lenders. Did I misinterpreted something?
Ah. I didn't know that. Thanks. That makes sense given that they have to issue "shares" instead of deposits.
So the way MMMFs usually "soak up" funds is by pulling deposits away from other depository institutions rather than by borrowing overnight? Is that right?
If so, here's a reworked version of my last question:
How much interest are MMMFs paying on their shares? How does it compare to interest on other forms of deposits? How does it compare to the market rate for overnight borrowing? How does it compare to the ON RRP rate?
Functionally, it sounds like the MMMFs are still doing the equivalent of levering. But they're calling their deposit liabilities "equity shares" in order to get away with it.
Gotcha, makes sense (and wasn't trying to be dense). All very good questions. Yes, MMFs attract funds in two main ways from my point of view: ability to offer higher returns than normal deposits, and because banks will push their large institutional depositors into their MMF products.
MMFs offering rates vary by the market, a function of their management fees, expense ratios (overhead costs) as well as money market rates. Right now, the interest they offer to investors is higher than deposits given low deposit betas of the banks w/ bloated balance sheets (remember, banks don't want deposits right now, so they push to their MMF products off their balance sheet - thus, banks have NO incentive to raise deposit rates to attract deposits. Brief caveat is that this is the banking sector as a whole, there are individual banks that want deposits and will pay for them).
Think of the rate that MMFs offer clients as a blend of all of the products they invest in, so they are very much contingent on what market funding rates are. It also depends on what type of MMF they are - prime can invest in riskier instruments like CP, but government funds can only invest in govies or o/n repo backed by them (i.e. tri-party). But they will certainly be paying *less* than the rates on money markets given they will net out their overhead costs as discussed above.
I'm not sure I agree that they are actually levering. Look at their capital structure: their liabilities are not credit instruments really. They're equity shares. Its entirely capital, not leverage. If you're trying to make a point that they're collecting a spread between money market rates and their investors/depositors, then I agree - there is some sort of intermediation going on here for sure. But in a balance sheet perspective, I wouldn't think of this as leverage.