The COVID-19 pandemic continues to have severe effects on the US economy, with historically low interest rates driving businesses to reconsider their cash management strategies. In this volatile liquidity landscape, how can businesses successfully navigate their operating cash goals? T om Meiman, Product Line Manager for Liquidity Balances and Demand Deposit Account Services, BNY Mellon Treasury Services, and Sam Schwartzman, Head of the IMG Cash Solutions Group, BNY Mellon Markets, explore.
Over the past decade, US liquidity has been significantly affected by short-term low interest rates, imposed following the 2008 global financial crisis. In 2015, the US dollar strengthened against other major world currencies and rates began to increase slowly through 2018, followed by some modest reductions in 2019.
The current unprecedented environment caused by the pandemic has placed further pressure on these short-term USD rates. As uncertainty rose in March, over US$1 trillion was moved into Government and Treasury money market funds (MMFs) over approximately a six-week period. The massive increase in demand, occurring in such a short time frame, temporarily pushed T-bill and overnight Treasury repo rates below zero at times. Elsewhere, LIBOR rates were greatly affected in March, with credit spreads widening.
Although T-bills and overnight Treasury repo rates are now positive (albeit T-bills have begun declining again of late) and LIBOR rates are leveling out, businesses are still waiting to see the long-term effects of the pandemic – with the added threat of a second or third wave. So, as banks look to successfully navigate the uncertain and turbulent liquidity landscape, how can they optimise their excess operating cash?
With the markets reaching new levels of instability in March and April, swift regulatory and legislative measures were introduced. For example, the Fed has so far delivered an unprecedented $3 trillion in additional liquidity to the US market.
To ensure that credit continued to flow to businesses and households, and so that the financial system did not amplify the shocks to the economy, the Coronavirus Aid, Relief and Economic Security (CARES) Act was passed. The $2.2 trillion stimulus bill – the largest emergency aid package in U.S. history – provided a much-needed injection of liquidity in the market.
The Fed also eliminated banks’ reserve requirement—the percentage of deposits that banks must hold as reserves to meet cash demands. Although banks generally hold far more than the required reserves, this unprecedented move has freed up additional liquidity for banks to use to lend to individuals and businesses.
The Fed has also temporarily – until March 31, 2021 – eased its supplemental leverage ratio rule (SLR), a non-risk weighted capital that affects large banks. This has allowed bank holding companies to exclude cash and Treasury securities from calculating their total assets –effectively reducing the amount of capital they are required to hold. This approach was particularly valuable at the height of the market crisis, as it ensured banks were not constrained by the influx of deposits that would have significantly affected their SLRs, thereby freeing up their balance sheets and providing further liquidity to the market.
There are numerous other programs that have been enacted by the Fed to secure additional liquidity – with some of the most prominent measures including the Money Market Mutual Fund Liquidity Facility (MMLF), the Primary Dealer Credit Facility (PDCF), the Primary Market Corporate Credit Facility (PMCCF), the Municipal Liquidity Facility (MLF) and the Term Asset-Backed Securities Loan Facility (TALF). With more initiatives in the pipeline, it is expected that the Fed’s balance sheet will continue to expand.
The short-term market rates forecast
Although the regulatory actions have provided valuable relief, market participants face considerable challenges, with the forecast for short-term market rates remaining uncertain.
Following the initial phase of the crisis, T-bill rates were steadily rising, but have since flattened and have even
begun to decline. If T-bill rates trend upwards again, and banks begin to move deposits away from the Fed into the T-bill market in search of yield, a near term cap could be put on these rates.
Elsewhere, LIBOR rates have been somewhat flat of late after blowing out in March and April and then coming back down to (in some cases) historically low levels. We do expect them to remain relatively flat going forward, assuming a resurgence of the market volatility seen in March and April does not occur.
MMF yields are still on a downward trajectory, and have generally not bottomed out yet, because the funds are somewhat benefitting from holding securities purchased in March – prior to when the two Fed interest rate cuts took effect. This lag effect will run its course shortly.
Fed funds’ rates are predicted to remain close to zero for the foreseeable future, largely due to continued weakness in economic activity and actions taken by the Federal Reserve. That said, assuming rate predictions hold, rates are currently not expected to go negative.
Utilising excess operating cash
What tools can cash managers employ to effectively optimise their excess operating cash during these volatile times? Due to the recent turbulence in the market, there has been an influx of cash into the short-term market space, with a focus on bank deposits through several different options.
Demand deposit accounts have been a cash management staple for decades. Popular due to their non-interest-bearing nature, they do not have any direct tax obligations. They are used to offset expenses, making them the ultimate transaction account – flexible and safe, with cash available on demand. Other instruments being utilised to maximise operating cash include sweeps, intraday investments, interest bearing accounts, hybrid accounts and netting and pooling – each with their own distinct advantages.
Off-balance sheet investment options may be equally viable for some cash managers and can prove valuable to different clients at different times. Another popular option is the Fixed Income Clearing Corporation (FICC) SMP repo program, which has been heavily utilised in recent years. This is because the traditional intermediary role that many banks and broker dealers played in the repo market has been reduced due to regulations restricting how they can participate in that market from a capital perspective. It is expected that the increase in FICC repo popularity will continue to grow.
A negative USD rate
Over the past 10 years, the US liquidity landscape has been faced with near zero interest rates. In this unique time of disruption, businesses face further challenges when it comes to navigating the volatile landscape – including the possibility of moving towards a negative rate.
The US has the advantage of being able to learn from the experience of other currencies and markets that have gone down the negative rate route. The Euro and the Japanese Yen have both dropped below zero in recent years, which proved less of a setback than it was once thought to be. That said, one big differentiator that would need to be considered is the size of the money market fund industry in these currencies compared to the US.
Although the Fed has made it clear that it will do all it can do avoid a negative rate and BNY Mellon is currently not projecting a negative environment, market participants must plan for a host of different eventualities. Clients need to be informed, understand their options and plan for an array of scenarios. What’s more, organisations need to be mindful of the potential impact of using such tools if rates did drop below zero.
It is up to banks to help ensure their clients are prepared with the knowledge of the short-term liquidity tools available to them, and the potential consequences of various market shifts on those solutions, to enable them to successfully navigate the shifting landscape.
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.
 Crane Data
Oil extends losses as Texas prepares to ramp up output
By Ahmad Ghaddar
LONDON (Reuters) – Oil prices fell from recent highs for a second day on Friday as Texas energy firms began to prepare for restarting oil and gas fields shuttered by freezing weather.
Brent crude futures were down $1.16, or 1.8%, to $62.77 per barrel, by 1150 GMT, while U.S. West Texas Intermediate (WTI) crude futures fell $1.42, or 2.4%, to $59.10 a barrel.
Unusually cold weather in Texas and the Plains states curtailed up to 4 million barrels per day (bpd) of crude oil production and 21 billion cubic feet of natural gas, according to analysts.
Texas refiners halted about a fifth of the nation’s oil processing amid power outages and severe cold.
However, firms in the region on Friday were expected to prepare for production restarts as electric power and water services slowly resume, sources said.
“The market was ripe for a correction and signs of the power and overall energy situation starting to normalise in Texas provided the necessary trigger,” said Vandana Hari, energy analyst at Vanda Insights.
Oil fell despite a surprise fall in U.S. crude stockpiles in the week to Feb. 12, before the freeze. Inventories fell by 7.3 million barrels to 461.8 million barrels, their lowest since March, the Energy Information Administration reported on Thursday. [EIA/S]
The United States on Thursday said it was ready to talk to Iran about both nations returning to a 2015 agreement that aimed to prevent Tehran from acquiring nuclear weapons.
While the thawing relations could raise the prospect of reversing sanctions imposed by the previous U.S. administration, analysts did not expect Iranian oil sanctions to be lifted anytime soon.
“This breakthrough increases the probability that we may see Iran returning to the oil market soon, although there is much to be discussed and a new deal will not be a carbon-copy of the 2015 nuclear deal,” StoneX analyst Kevin Solomon said.
(Additional reporting by Roslan Khasawneh in Singapore and Sonali Paul in Melbourne; editing by Jason Neely)
Analysis: Carmakers wake up to new pecking order as chip crunch intensifies
By Douglas Busvine and Christoph Steitz
BERLIN (Reuters) – The semiconductor crunch that has battered the auto sector leaves carmakers with a stark choice: pay up, stock up or risk getting stuck on the sidelines as chipmakers focus on more lucrative business elsewhere.
Car manufacturers including Volkswagen, Ford and General Motors have cut output as the chip market was swept clean by makers of consumer electronics such as smartphones – the chip industry’s preferred customers because they buy more advanced, higher-margin chips.
The semiconductor shortage – over $800 worth of silicon is packed into a modern electric vehicle – has exposed the disconnect between an auto industry spoilt by decades of just-in-time deliveries and an electronics industry supply chain it can no longer bend to its will.
“The car sector has been used to the fact that the whole supply chain is centred around cars,” said McKinsey partner Ondrej Burkacky. “What has been overlooked is that semiconductor makers actually do have an alternative.”
Automakers are responding to the shortage by lobbying governments to subsidize the construction of more chip-making capacity.
In Germany, Volkswagen has pointed the finger at suppliers, saying it gave them timely warning last April – when much global car production was idled due to the coronavirus pandemic – that it expected demand to recover strongly in the second half of the year.
That complaint by the world’s No.2 volume carmaker cuts little ice with chipmakers, who say the auto industry is both quick to cancel orders in a slump and to demand investment in new production in a recovery.
“Last year we had to furlough staff and bear the cost of carrying idle capacity,” said a source at one European semiconductor maker, who spoke on condition of anonymity.
“If the carmakers are asking us to invest in new capacity, can they please tell us who will pay for that idle capacity in the next downturn?”
The auto industry spends around $40 billion a year on chips – about a tenth of the global market. By comparison, Apple spends more on chips just to make its iPhones, Mirabaud tech analyst Neil Campling reckons.
Moreover, the chips used in cars tend to be basic products such as micro controllers made under contract at older foundries – hardly the leading-edge production technology in which chipmakers would be willing to invest.
“The suppliers are saying: ‘If we continue to produce this stuff there is nowhere else for it to go. Sony isn’t going to use it for a Playstation 5 or Apple for its next iPhone’,” said Asif Anwar at Strategy Analytics.
Chipmakers were surprised by the panicked reaction of the German car industry, which persuaded Economy Minister Peter Altmaier to write a letter in January to his counterpart in Taiwan to ask its semiconductor makers to supply more chips.
No extra supplies were forthcoming, with one German industry source joking that the Americans stood a better chance of getting more chips from Taiwan because they could at least park an aircraft carrier off the coast – referring to the ability of the United States to project power in Asia.
Closer to home, a source at another European chipmaker expressed disbelief at the poor understanding at one carmaker of how it operates.
“We got a call from one auto maker that was desperate for supply. They said: Why don’t you run a night shift to increase production?” this person said.
“What they didn’t understand is that we have been running a night shift since the beginning.”
NO QUICK FIX
While Infineon, the leading supplier of chips to the global auto industry, and Robert Bosch, the top ‘Tier 1’ parts supplier, both plan to commission new chip plants this year, there is little chance of supply shortages easing soon.
Specialist chipmakers like Infineon outsource some production of automotive chips to contract manufacturers led by Taiwan Semiconductor Manufacturing Co Ltd (TSMC), but the Asian foundries are currently prioritising high-end electronics makers as they come up against capacity constraints.
Over the longer term, the relationship between chip makers and the car industry will become closer as electric vehicles are more widely adopted and features such as assisted and autonomous driving develop, requiring more advanced chips.
But, in the short term, there is no quick fix for the lack of chip supply: IHS Markit estimates that the time it takes to deliver a microcontroller has doubled to 26 weeks and shortages will only bottom out in March.
That puts the production of 1 million light vehicles at risk in the first quarter, says IHS Markit. European chip industry executives and analysts agree that supply will not catch up with demand until later in the year.
Chip shortages are having a “snowball effect” as auto makers idle some capacity to prioritize building profitable models, said Anwar at Strategy Analytics, who forecasts a drop in car production in Europe and North America of 5%-10% in 2021.
The head of Franco-Italian chipmaker STMicroelectronics, Jean-Marc Chery, forecasts capacity constraints will affect carmakers until mid-year.
“Up to the end of the second quarter, the industry will have to manage at the lean inventory level,” Chery told a recent Goldman Sachs conference.
(Douglas Busvine from Berlin and Christoph Steitz from Frankfurt; Additional reporting by Mathieu Rosemain and Gilles Gillaume in Paris; Editing by Susan Fenton)
Aussie and sterling hit multi-year highs on recovery bets
By Tommy Wilkes
LONDON (Reuters) – The Australian dollar rose to near a three-year high and the British pound scaled $1.40 for the first time since 2018 on optimism about economic rebounds in the two countries and after the U.S. dollar was knocked by disappointing jobs data.
The U.S. currency had been rising in recent days as a jump in Treasury yields on the back of the so-called reflation trade drew investors. But an unexpected increase in U.S. weekly jobless claims soured the economic outlook and sent the dollar lower overnight.
On Friday it traded down 0.3% against a basket of currencies, with the dollar index at 90.309.
The Aussie rose 0.8% to $0.784, its highest since March 2018. The currency, which is closely linked to commodity prices and the outlook for global growth, has been helped by a recent rally in commodity prices.
The New Zealand dollar also gained, and was not far off a more than two-year high, while the Canadian dollar rose too.
Sterling rose to $1.4009 on Friday, an almost three-year high amid Britain’s aggressive vaccination programme.
Given the size of Britain’s vital services sector, analysts say the faster it can reopen the economy, the better for the currency. Sterling was also helped by better-than-expected purchasing managers index flash survey data for February.
The U.S. dollar has been weighed down by a string of soft labour data, even as other indicators have shown resilience, and as President Joe Biden’s pandemic relief efforts take shape, including a proposed $1.9 trillion spending package.
Despite the recent rise in U.S. yields, many analysts think they won’t climb too much higher, limiting the benefit for the dollar.
“Our view remains that the Fed will hold the line and remain very cautious about tapering asset purchases. We think it will keep communicating that tightening is very far off, which should dampen pro-dollar sentiment,” said UBS Global Wealth Management strategist Gaétan Peroux and analyst Tilmann Kolb.
ING analysts said “the rise in rates will be self-regulating, meaning the dollar need not correct too much higher”.
They see the greenback index trading down to the 90.10 to 91.05 range.
The euro rose 0.4% to $1.2134. The single currency showed little reaction to purchasing manager index data, which showed a slowdown in business activity in February. However, factories had their busiest month in three years, buoying sentiment.
The dollar bought 105.39 yen, down 0.3% and a continued retreat from the five-month high of 106.225 reached Wednesday.
(Editing by Hugh Lawson and Pravin Char)
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