personal views of a fed insider

Tag: financial plumbing

Negative Net Yields

Money is being poured into the system, and it has no where to go. The ON RRP is the escape valve, but it is fixed at 0% when money market fund (“MMF”) management fees are around 0.2%. The stars are aligned for continued flow into the money fund space, pushing front end rates towards 0% as it ultimately flows down the ON RRP drain. The Fed will continue to pump $120b/month into the banking system, European bank balance sheets will be less willing to hold additional liquidity under daily average reporting (see this post), and SLR/LCR constraints will eventually bind big U.S. banks (see this post). MMFs have been waiving their fees to keep net yields positive (without waivers Fidelity’s flagship Govie fund would yield -0.09%), but that can’t last forever. Negative net yields are coming. Cash investors are unlikely to idly sit and watch their money evaporate. In this post we outline some options for cash investors, show why the marginal flows will move abroad, and suggest that this is functionally a surgical rate cut.

Fidelity’s $130b Institutional Gov Fund (FRGXX) would be increasingly negative yielding without fee waivers
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SLR Sets Size, But LCR Shapes Composition

It looks like SLR relief is ending, even as the Fed is set to continue turbo QE. A bank’s balance sheet is like an office building – it can only accommodate so many tenants, and the bank wants the best tenants it can get. The size of the building is set by the leverage ratio, and tenants are judged by metrics that include their commercial value and costs. Right now there are many more potential tenants than vacant offices, so banks maximize returns by forcing the least profitable tenants out. As discussed before, banks will use negative rates to do this. The Liquidity Coverage Ratio (“LCR”) is one of the key metrics banks use to assess the costs of their tenants. In this post I sketch out why banks will push some deposits outs, how deposits are judged under the LCR, and where those deposits will end up.

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