Navigating Volatility in the USD Landscape
In this unique time of disruption, U.S. businesses face a challenging marketplace in which interest rates are not only historically low, but may possibly go negative. Here’s how treasurers can achieve their operating cash goals in this unprecedented environment.
For more than a decade, the U.S. liquidity landscape has been dominated by low short-term interest rates, enacted to stimulate the economy at the height of the 2008 financial crisis. Throughout 2020, unprecedented pressures weighed on the markets for prime money-market funds (MMFs) and other popular vehicles for stashing corporate cash. At the height of the Covid-19 crisis in March of last year, this environment resulted in short-term rates for some U.S. dollar (USD)–denominated securities turning negative.
During that period, demand overwhelmed supply at the very short end of the Treasury/repurchase market, as concerns about credit risk surged. Between mid-March and the end of April 2020, over $1 trillion moved into government and Treasury MMFs. This abrupt increase in demand sent Treasury bill and overnight Treasury repurchase agreement (repo) rates temporarily below zero at times.
T-bill rates have since returned to positive territory, and they have stayed positive—currently ranging from the low to mid single digits—due primarily to the large volume of new issuance that has been made available to help fund the U.S. stimulus packages. In addition, government and Treasury MMFs saw net outflow activity in the second half of 2020, which reduced the demand for T-bills, helping to support yields. Somewhat lower demand from these MMFs has also helped to generally keep overnight Treasury repo rates out of negative territory.
London interbank offered rate (LIBOR) benchmarks were greatly affected in March, with credit spreads widening, as is often the case in periods of market volatility. Those rates have since narrowed considerably and returned to relatively normal levels. Rates had been trending lower for USD MMFs for most of 2020. Yields on Treasury and government funds have now settled in the range of zero to low single digits, as MMF companies have started to utilize waivers to avoid yields going to zero or below. Prime-fund yields are somewhat higher, but still generally in the single-digits range.
Initiatives That Injected Liquidity into Markets
The U.S. regulatory and legislative response to the pandemic has been crucial for businesses navigating the market volatility. Much of the focus of the Fed and government relief efforts has been on increasing liquidity. As a result, the Fed has injected over $3 trillion into the markets since March 2020, and that number is increasing on a monthly basis as a result of ongoing quantitative easing efforts.¹
Among the additional initiatives introduced to support the U.S. economy, the $2 trillion Coronavirus Aid, Relief, and Economic Security (CARES) Act was the largest emergency-aid package in U.S. history. The December 2020 and March 2021 stimulus packages have further supported the U.S. economy.
The Fed’s decision to remove the reserve requirement ratio on deposits was another significant development, as the change removed the stipulation that banks set aside a percentage of their assets as cash at the Federal Reserve. This move was unprecedented, and it has freed up liquidity for banks to lend to individuals and businesses.
Another key pandemic-driven regulatory change was the update to the supplementary leverage ratio (SLR), a non-risk-weighted capital metric that affects large banks. The temporary change—which came to an end on March 31—saved bank holding companies from factoring Fed positions and Treasury holdings into their SLR calculations. During March and April of 2020, this ensured that banks were not constrained by the influx of deposits they experienced, which would have significantly affected the banks’ SLR capital requirements under the previous rules. Instead, banks’ balance sheets were freed up and they were able to extend more credit and provide more liquidity to the market.
A host of other Fed programs provided additional liquidity during the height of the crisis period, including the Money Market Mutual Fund Liquidity Facility (MMLF); the Municipal Liquidity Facility (MLF); the Main Street Lending Program; and the Term Asset-Backed Securities Loan Facility (TALF), an initiative to provide liquidity to the securitization market. (Note that these programs have now expired.)
Furthermore, the Fed’s balance sheet has grown considerably as it has provided massive amounts of liquidity in response to the pandemic. For example, the Fed has purchased a large volume of Treasuries and mortgage-backed securities and plans to continue doing so for the foreseeable future.
The Outlook for Short-Term Rates
As further initiatives to stimulate the economy are rolled out and the consequences of the pandemic evolve, treasurers and risk managers will continue to face a volatile market landscape. So, what is the outlook for short-term interest rates?
The federal funds rate is expected to stay very close to zero for an extended period, with the target range remaining between 0 basis points (bps) and 25 bps. T-bill rates flattened last autumn, and they are predicted to remain roughly at these levels for some time. As long as we don’t experience a resurgence of the market volatility seen in the spring of 2020, we can also expect LIBOR rates to remain somewhat flat going forward.
Yields on most Treasury and government MMFs have hit bottom for the near term, as funds are choosing to waive fees rather than let yields go negative. However, corporate cash managers need to plan for that possibility: Yields on some funds may fall below zero as soon as fund companies stop waiving their fees.
Rates for prime funds are likely to stay a bit higher than those of the government and Treasury repo funds. Nevertheless, we predict that yields for prime MMFs will settle in the low single digits.
Optimizing Excess Operating Cash
During these particularly volatile times, cash managers require an assortment of tools to optimize their excess operating cash, including both on- and off-balance-sheet options. Their on-balance-sheet options include:
Demand deposit accounts (DDAs). The cash management staple for decades, these are non-interest-bearing (NIB) accounts that do not have any direct tax obligations because they do not generate any hard dollar income. These accounts may offer complete liquidity of balances to facilitate payment transactions on demand. Some NIB accounts may generate earnings credits to offset bank fees.
In addition to making payments, corporate cash managers use DDAs to concentrate funds to a primary account, leaving a zero balance in the source account to simplify reconciliation. DDAs are the ultimate transaction account, providing security, flexibility, and cash on demand.
End-of-business-day investment passive-sweep accounts. Cash managers typically use this type of account to support transactions throughout the business day in the United States, then to automatically post funds to an alternative entity—often non–U.S.-based—to facilitate certain liquidity functions overnight. The next morning, the cash automatically returns to the pre-sweep accounts. This structure is slightly on the wane.
Intraday investment sweep with MMF options. This type of account will automatically move excess funds into another specified account, such as a higher-yielding investment account or an MMF that may generate dividend income rather than interest income from a bank deposit. It typically performs the sweeps in mid to late afternoon U.S. Eastern time.
Interest-bearing accounts. These have grown in popularity in recent years, as corporate cash managers have become increasingly willing to move out of the non-interest-bearing earnings credit allowance environment toward solutions that generate interest income. Corporate cash managers’ interest-bearing accounts function transactionally, just like non-interest-bearing accounts, but they generate interest. Having this option provides more flexibility for the cash manager.
Hybrid accounts. A highly regarded option across a range of businesses, hybrid accounts provide both earnings credits and credit interest. They tend to be more popular when interest rates are higher—when the federal funds rate is above 125 bps to 150 bps.
Netting and pooling. Where these features are permitted by law, they are stalwart tools wielded by many treasury professionals. Currently, companies tend to use these types of solutions primarily outside the United States, but U.S. organizations are increasingly exploring them for domestic use as well.
Money-market deposit accounts. While popular in the past, this solution has seen a drop in demand following the Fed’s removal of the reserve requirement.
Meanwhile, corporate cash managers’ off-balance-sheet options include:
Direct purchases of securities. Cash managers can increase investment income by putting their cash in short-term securities, through outright purchases of T-bills, agency securities, commercial paper, etc.
MMFs. Many treasury teams utilize money-market funds, which are available in a range of varieties. For example, some MMFs hold only Treasuries; some have Treasuries and repos that are backed by Treasuries; some have Treasuries and agency securities; and some hold commercial paper, CDs, etc. Within the United States, the four largest types of MMFs in terms of assets are U.S. Treasury repo funds, U.S. government MMFs, U.S. Treasury-only funds, and U.S. prime funds. In the offshore USD space, treasurers primarily utilize prime funds and Treasury repo funds.
Fixed Income Clearing Corporation (FICC)–sponsored repo. FICC repo is an outlet—from both a financing and a cash perspective—that corporate treasurers have been utilizing much more heavily in recent years. As a result, the market has seen growth on the scale of hundreds of billions of dollars. This is because the intermediary role that banks and broker-dealers traditionally played in the repo market has been reduced by regulations restricting how they can participate in that market from a capital perspective.
FICC repo enables a bank to sponsor a client to either finance or invest in repo. The bank executes both sides of the trade—engaging in a reverse repo with an entity that needs financing, and separately executing a repo with an entity that has cash. That bank then novates the trade to FICC. This results in a much-reduced capital impact for the bank, while facilitating market supply elsewhere. We expect FICC to continue growing in popularity, particularly in the current rate environment when yields offered on FICC repo are often higher than yields on other short-term investment options.
According to a BNY Mellon survey conducted in June 2020, MMFs are the most popular investment instrument for U.S. companies’ operating cash, with 43 percent of respondents selecting MMFs as their preferred tool for short-term investments. This was followed by both bank deposits and direct government securities (i.e., T-bills/notes), each selected by 27 percent of respondents. Only 3 percent of respondents invest primarily in repo.
Meanwhile, among bank deposit accounts, interest-bearing DDAs are the most popular, with 61 percent of respondents selecting these as their primary instrument used. Thirty percent of respondents primarily use non-interest-bearing earnings credit accounts, while hybrid accounts and time deposits/CDs were selected by 4 percent each. These results reflect the fact that a lot of the value of hybrid accounts has decreased as rates have fallen.
See also:
- Treasury & Risk “2020 Cash Management Survey” report—Leading with Liquidity: Post-Pandemic Cash Management Realities
- Money Fund Madness in March
- MMF Opportunity in Volatile Markets
Potential Consequences Should USD Rates Go Negative
U.S. markets grappled with near-zero rates for almost a decade following the global financial crisis, and recent events are driving further complexities. Although negative rates were never implemented in the early 2010s, they may now be on the horizon. One indicator is that from 2008 to 2015, the Fed’s rate for interest on excess reserves remained at 25 bps; that rate is now at a low of 10 bps.
While the Fed has been very clear that it will use every means available to avoid a negative rate, and BNY Mellon is not currently projecting a negative environment for USD, prudent cash managers are planning for such a possibility because rates are so close to zero and uncertainty is so high. What would the consequences be for businesses using short-term liquidity tools?
Earnings credits might also simply cease in a negative-USD environment, depending on the responses of individual providers. For example, the core billing applications may be designed to stop generating credits when a zero rate is implemented, so negative credits—or, essentially, earnings debits—would not be applied. Of course, some providers’ systems might continue to generate and apply earnings “credits,” regardless of whether the interest rate is positive or negative. Balances with those providers might therefore switch from non-interest-bearing to interest-bearing and become subject to negative interest under certain conditions.
If rates do go negative, cash managers must be mindful of the potential for debits on their operating cash balances. A provider applying negative interest would likely do so either via account debits or as an analysis charge on a monthly statement.
Of course, negative rate determinations must be subject to the specific environment that is encountered, dependent on factors such as how far below zero market and central bank rates have gone, as well as bank balance sheet considerations. Since there is not an industry standard for reacting to negative interest rates, different financial institutions would undoubtedly address these dynamics in different ways.
As businesses struggle to optimize their excess operating cash throughout 2021, their banks need to arm corporate treasury teams with knowledge about their cash management options, as well as the potential ramifications that various market shifts might have on those solutions.
We are in the midst of significant disruption, and planning for different eventualities is vital. Should negative rates happen, cash managers need to have contingency plans that prepare them to react in the way that will optimally harness the suite of tools available.
The views expressed herein are those of the authors only and may not reflect the views of BNY Mellon. This does not constitute Treasury Services advice, or any other business or legal advice, and it should not be relied upon as such.