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The US liquidity landscape: Navigating uncertain times

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The US liquidity landscape: Navigating uncertain times 1

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[1]. 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?

Regulatory response

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

Tom Meiman

Tom Meiman

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.

Sam Schwartzman

Sam Schwartzman

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.

[1] Crane Data

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