The Federal Reserve’s floor for overnight funding markets is proving to be no match for the deluge of cash. 

Money-market securities ranging from Treasury bills to repurchase agreements continue to trade below 0.05% -- the offering rate on the overnight reverse repo (RRP) facility, which is supposed to act like a floor for the front end. The Fed at its June meeting had adjusted the rate by 5 basis points to help support the smooth functioning of short-term funding markets. Still, usage of the tool rose to a record $1.136 trillion on Monday, eclipsing the previous all-time high of $1.116 trillion on Aug. 18. 

Demand for the so-called RRP facility has surged as a flood of dollars continues to overwhelm the funding markets. That’s in part a result of the central bank’s continuing asset purchases and drawdowns of the Treasury’s cash account, which is pushing reserves into the system. As a result, liquidity has continued to swell, especially as the Treasury cuts supply to create more borrowing room under the debt ceiling.

'Soft Floor for Money Market Rates'

“The Fed’s technical adjustment earlier this year is not a panacea for the money markets,” JPMorgan Securities strategists Teresa Ho and Alex Roever wrote in a note. “Supply and demand technicals remain an overarching driver of rates, and with the supply and demand gap now having grown to $1.35 trillion, it’s not surprising that the Fed’s ON RRP is providing only a soft floor for money market rates.” 

The strategists expect that this distortion will linger, even after the Fed begins reducing its asset purchases from $120 billion per month. Even if the central bank were to complete tapering by August 2022, as JPMorgan expects, there could still be an additional $850 billion to $1 trillion of additional liquidity injected into the financial system. 

While Treasury bill supply is expected to rebound once the debt ceiling limit is resolved, it’s still to be determined as to when that will be. Bills maturing at the end of October and through November are yielding more than the securities surrounding those dates. 

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