In the case of excessive liquidity, the imbalance between supply and demand drives money market interest rates to zero.
JPMorgan Chase & CoSaid the Fed's technological adjustment earlier this year was not a panacea for the market.
The bottom of interest rates the Fed has built for the overnight funding market is vulnerable to surging liquidity.
From US Treasuries to repurchase agreements, interest rates on a variety of money market securities remain below the Fed's overnight reverse repo rate of 0.05 per cent, which should have been seen as the floor of short-term interest rates. At its June meeting, the Fed adjusted the overnight reverse repo rate by five basis points to help support the smooth operation of short-term funding markets. But,On Monday, the use of overnight reverse repurchase tools reached another record, reaching 1.136 trillion US dollars.Surpassing the previous record of $1.116 trillion hit on Aug. 18.
Demand for reverse repos has surged as large amounts of dollars continue to overwhelm the financing market. The surge in liquidity is partly due to the Fed's continued asset purchases and the US Treasury's withdrawal of money from cash accounts, pushing more reserves into the system. The Treasury's move to cut US debt issuance to make room for the debt ceiling has further exacerbated the flood of liquidity.
"the Fed's technical adjustment earlier this year is not a panacea for money markets," JPMorgan Chase & Co Securities strategists Teresa Ho and Alex Roever wrote in a report. "the technical factors affecting supply and demand remain the main driver of the interest rate market, and now that the gap between supply and demand has widened to $1.35 trillion, it is not surprising that the Fed's overnight reverse repo rate can only serve as a" soft bottom "."
These strategists expect the distortion to continue even if the Fed starts to reduce its asset purchases by $120 billion a month. Even if the Fed completes the downsizing as expected by JPMorgan Chase & Co in August 2022, an additional $850 billion to $1 trillion in liquidity could still be injected into the financial system.
Although Treasury issuance is expected to rebound once the debt ceiling is resolved, it is still unclear when it will happen.