Financial headlines continue to warn of the potential for broader financial stresses as usage of some short-term lending programs have surged to record levels recently. The size of the moves has some analysts warning that the markets for short-term funding are vulnerable to disruption. As the lifeblood for many corporations, any potential disruption in the short-term funding markets could have spillover effects into the real economy.
“While we’re always on the lookout for early warning signs, we don’t think short-term funding markets are flashing those warning signs right now,” noted LPL Financial Fixed Income Strategist Lawrence Gillum. “We think this is a case of too much money chasing too few safe investments.”
Why are short-term funding markets important?
Short-term funding markets are important as they connect the financial markets to the real economy. Commercial paper, money market mutual funds, repo and reverse repo markets are the more popular short-term funding markets as they tend to be very large and liquid markets. Companies use these markets to manage many day-to-day expenses like payroll. In 2008, when the commercial paper market froze-up, companies had to tap expensive lines of credit to make their day-to-day expenses or fail to honor their short-dated commitments. However, now usage at the Fed’s reverse repo program has surged to record amounts recently so when these markets start to “act” abnormally its right to pay attention to any signal that they may be providing.
What is the Federal Reserve’s (Fed) reverse repo program?
As seen in the LPL Research Chart of the Day, usage of the Fed’s reverse repo program has consistently topped $1 trillion recently—the most by far since the Fed created the program back in 2013. The Fed’s reverse repo program is a program that allows short-term investors, such as banks and money market funds, to invest excess cash overnight. Mechanically, the Fed sells a security, usually a Treasury bill, to an eligible counterparty with an agreement to repurchase that same security at a specified price at a specific time in the future. The difference between the sale price and the repurchase price, together with the length of time between the sale and purchase, implies a rate of interest paid by the Federal Reserve on the transaction. Short-term investors have historically used the program when they don’t want to take counterparty risk because they won’t know for sure if their trading partner will be around the next day. That we are consistently seeing more than $1 trillion move into this program is worrying some investors.
Are short-term funding markets flashing warning signs?
We don’t think the record amount of money flowing into the Fed’s reverse repo program presages a market event at this time. Central banks continue to provide emergency level monetary accommodation while, at the same time, Treasury bill supply has been dwindling as the Treasury tries to create more borrowing room under debt ceiling constraints. This, in our view, is a case of excess cash looking to add any incremental return in a yield starved world awash with liquidity. Moreover, when we look at corporate credit markets, which also tend to presage market events, they continue to remain well behaved. Option-adjusted spreads, or the additional compensation for holding riskier debt, remain near historical lows. If there were troubles on the horizon we would likely see multiple markets flashing warning signs, which we’re just not seeing right now.
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change. References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy. All index and market data from FactSet and MarketWatch. This Research material was prepared by LPL Financial, LLC. Securities and advisory services offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC). Insurance products are offered through LPL or its licensed affiliates. To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.
- Not Insured by FDIC/NCUA or Any Other Government Agency
- Not Bank/Credit Union Guaranteed
- Not Bank/Credit Union Deposits or Obligations
- May Lose Value
For Public Use – Tracking # 1-05186373