(Reuters) - September’s sharp squeeze in money markets was scary but also proved to be instrumental in pulling the U.S. Federal Reserve off the sidelines, a moment that will prove pivotal for assets well beyond short-term funding markets, the head of fixed income for the world’s largest fund manager said on Thursday.
Over the course of a handful of days in mid-September, cash available to banks for their short-term funding needs all but dried up, and interest rates in U.S. money markets shot up to as high as 10% for some overnight loans, more than four times the Fed’s rate.
While jarring, the outcome of the event - with the Fed now providing billions of dollars in daily cash injections and building back up its stash of bonds through $60 billion a month of Treasury bill purchases - has reassured Rick Rieder, chief investment officer for fixed income at BlackRock Inc (BLK.N), that the U.S. central bank is back in the business of providing sorely needed liquidity.
The “funding scare was a seminal moment,” Rieder said at the Reuters Global Investment Outlook 2020 Summit.
The Fed’s actions - in tandem with three interest rate cuts since July - have helped steepen the U.S. Treasury yield curve, which had dropped into so-called inversion over the summer. An inverted yield curve, when yields on shorter-duration bonds are higher than those for longer-dated maturities, is a classic signal of approaching economic recession.
Since then, for instance, the spread between yields on 10-year and 2-year Treasury notes has climbed by nearly 30 basis points, from around negative 5 to around positive 25 now. That relieves pressure on banks whose margins had become compressed and lowers the risk of wider weakness in the economy and financial markets more broadly, he said.
On top of that, U.S. stocks are back at record highs.
“Adding liquidity to the system is incredibly powerful,” Rieder said.
Moreover, Rieder said there is a reasonable chance the Fed will opt to remain in the balance sheet expansion business for longer than currently expected. At the moment, the Fed has signaled its plan is to buy $60 billion in bills a month through at least the first quarter of next year.
But with its roughly $4 trillion balance sheet amounting to less than 20% of U.S. gross domestic product, the Fed has much more room to continue building its asset portfolio than its main counterparts in Europe and Japan, Rieder said. The European Central Bank’s asset holdings are the equivalent of nearly 40% of the trading bloc’s GDP, while the Bank of Japan’s are more than 100% of that economy’s annual output.
Meanwhile, Rieder said the Fed is done cutting rates after having delivered three reductions since July. The Fed’s targeted overnight rate now stands at 1.50-1.75%, down from 2.25-2.50% at mid-year.
That said, they are not going to reverse those cuts any time soon, according to Rieder.
“I don’t think the Fed’s going to raise rates for a long time, and they’re going to let inflation run hot.”
Reporting by Dan Burns; Editing by Megan Davies and Howard Goller