Even when bond traders worry about another possible selloff on long-term Treasuries, those who rely on shorter maturities face the opposite problem. An avalanche of cash making its way into money markets has put pressure on overnight interest rates, while increasing acceptance of an obscure Federal Reserve facility to its highest levels since the pandemic sparked by the first time a global flight to safety last year. This, in turn, has raised concerns about the US central bank, which could be nearing the brink of losing control of its benchmark rate.
The facility allows lenders to offer funds to the central bank in exchange for US Treasuries and similar safe-haven assets at negligible interest rates. By doing so, the Fed can limit downward pressure on the Fed’s benchmark interest rate and keep it within its prescribed range. Part of the reason for the increased acceptance of this Fed’s facility, said John Canavan, an analyst at Oxford Economics, is that the inflow of cash into money market funds needs a place to find a home. Treasury accounts held at the Fed are expected to shrink as the Treasury Department depletes its cash hoard to fund the Biden administration’s stimulus plans. That automatically increases reserves in banks that will look for places to temporarily park funds, one of the selling points being the Fed’s ease of repurchase. See: 5 Reasons Negative Repurchase Rates Are Different From Last Crisis of overnight financing But its increased use has shed light on a conundrum facing the central bank in recent months. Interest rates on overnight loans, whether on the repo or Treasury bill markets, have periodically threatened to fall below zero. The concern is that the drop in these short-term loan rates may, in turn, drag the Fed’s own interest rate down closer to the bottom of its 0.25% to 0% range. The Fed’s effective federal funds rate stood at 0.07% on Tuesday. That has prompted calls for the Fed to change the interest rate on excess reserves or the rate of the overnight reserve buyback facility, arrangements that could ease pressure on money markets. However, Stephen Stanley of Amherst Pierpont says that as long as the Fed’s benchmark rate remains in positive territory, the central bank is unlikely to act at Wednesday’s meeting.