Some investors decide to play the new year by lending cash

While the Federal Reserve has lent billions of dollars every day to the replenishment market, some analysts and bankers are concerned that the central bank’s method of providing funds will limit the benefits of these loans and open the door to volatility. . The Fed works through a group of 24 large banks, known as major distributors, that act as the central bank’s sole counterparties when listed on financial markets. This network could limit the effectiveness of Fed replenishment programs if major distributors hold cash instead of lending it to other banks.

For those lending in the replacement market, such as money market funds and other investors with available cash, this scenario could present an opportunity.

Jeffery Elswick, director of fixed income at Frost Investment Advisors, said he benefited from having an unusually large amount of cash in September available to lend to the market. This experience prompted him to plan another year-end event, though he acknowledges that the Fed could increase lending programs enough to minimize hikes.

Elswick typically invests the company’s cash in assets that are commonly found in money market accounts, such as Treasury bills and replacement contracts. In September it had about $ 150 million in cash, which it was able to lend to the rest market. He said he plans to have up to $ 200 million available by the end of the year.

“When rates were rising, we would say,‘ Very well, today we are investing in 6% repo, ’” he said.

One of the factors to blame for the volatility of 2018 around the new year: the regulatory capital requirements of banks are determined by a snapshot of their holdings in late December. This recurring dynamic gives them an incentive to keep cash instead of lending them because small changes in their books could turn them into a higher or lower level of capital requirement for the following year.

Since the September rest rate hike, the Fed has taken steps to ease conditions in cash markets. Officials began injecting cash into the money markets for the first time since the financial crisis, offering billions of overnight loans to the rest market. They then added two-week replacement loans, increased the number of offers and pledged to continue them until well into next year. Fed officials also said they would buy $ 60 billion a month in Treasury bills.

These steps, and the potential for others, could reduce the risk of another year-end rise, analysts and investors said.

Still, nearly two months after the September replenishment market disruption and nearly two months of measures to provide Fed liquidity, demand for cash is not waning. This month, banks and other borrowers are bidding for an average of about $ 74 billion in one-night Fed loans, about 25% more than last month. Central bank officials have said they plan to continue offering loans during the second quarter.

“We’re preparing for a pretty big rise in volatility and replenishment rates in the fourth quarter,” said Nick Maroutsos, co-head of world bonds at Janus Henderson. This means making sure the company has cash available to lend if supply becomes scarce again and rates rise.

Maroutsos said he plans to sell short-term assets to build a larger cash position, which he intends to lend to the spare market and possibly use it to buy loans from short-term companies known as commercial paper.

Maroutsos is skeptical that Fed night loans will calm markets at the end of the year. “The likelihood of a tightening of the dollar is ultimately high,” he said.

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Write to Daniel Kruger to [email protected]