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US Treasury bills (T-bills) and repurchase agreements are among the most important instruments of global finance, and US money market funds (MMFs) play a key role as investors in these markets. By affecting T-bill rates, their portfolio allocation also impacts common measures of T-bills’ convenience yield. Our results have important implications for how previous work has interpreted the liquidity premium/convenience yields, as well as for monetary policy transmission, government debt issuance, and regulation of the MMF industry.
US Treasury bills (T-bills) and repurchase agreements (repos) are among the most important instruments of global finance. T-bills are considered highly liquid and viewed as the global risk- free asset, commanding a sizable convenience yield in the form of a safety and liquidity premium (Krishnamurthy and Vissing-Jorgensen, 2012; Greenwood, Hanson and Stein, 2015; Nagel, 2016). Repos are instrumental for banks and other financial institutions to raise short-term capital and manage liquidity needs, and the reverse repo (RRP) facility of the Federal Reserve constitutes a critical monetary policy instrument (Afonso et al., 2022a).
US money market funds (MMFs) play a key role as investors in markets for these near-money assets. MMFs are short-term investment vehicles with total assets under management of about $6 trillion as of mid-2023, equal to about 20% of US GDP or total commercial bank assets. MMFs’ investments in T-bills and repos amount to more than $3 trillion. On aggregate, MMFs’ average market share in the T-bill market is 20%, and their holdings significantly co-move with the T-bill supply, suggesting an important role for MMFs as marginal investors.
In a recent study (Doerr, Eren and Malamud, 2023), we present new evidence that MMFs’ portfolio allocations affect the pricing of T-bills, with important implications for how previous work has interpreted the liquidity premium. We argue that MMFs, as large players in repo and T-bill markets, take into account their market power in repo markets and their price impact in the T-bill market when deciding on how to allocate their assets under management. In particular, our theory predicts that when funds have more cash to invest in the T-bill market (what we call “residual cash”), this will have a negative price impact on T-bill rates and hence also affect common measures of the liquidity premium. Importantly, these effects are expected to be more pronounced when the Treasury market is illiquid and funds’ price impact greater....
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