By Karen Brettell

(Reuters) – Companies and money market investors who want to boost returns above zero should be able to take advantage of this year’s Federal Reserve stimulus.

It will be more difficult to manage short-term rate hikes and increase issuance of government bonds, but it is possible with some careful planning.

Very short-term investors have turned to the Fed’s reverse repurchase facility in record numbers, wherein the Fed takes cash and lends short-term securities overnight for a 5 basis point return, as cash holdings swell and investment options dwindle.

Investors may be now able to use their cash more effectively as interest rates increase, there is less supply on the market, and money holdings shrink. On Friday investors parked $1.60 trillion in the Fed’s reverse repo facility.

“With excess cash reduced, money market funds won’t have much use for the reverse repo facility,” said Scott Skyrm, executive vice president in fixed income and repo at Curvature Securities.

Fed officials are planning to raise the interest rate in March. Three or four more increases will be expected this year. These increase should lift yields for very short-term debts that have remained at historical lows.

“The notion of rate hikes is some welcome relief, at least to cash investors who have been plagued with near zero yields for almost two years at this point in time,” said Jerome Schneider, head of short-term portfolio management and funding at PIMCO.

Also, the Treasury expects to increase its issuance, having reduced it last year due to debt ceiling limitations. The supply will likely grow if this is followed by a reduction in U.S. central banking’s massive balance sheets later in the year. The Treasury will likely increase the short-term issuance it sells to the public if the Fed ceases reinvesting bonds that are past due.

DON’T GO TO BAD!

However, investors should avoid buying assets too quickly before the rates rise. In many cases, short-dated assets don’t reflect anticipated rate rises until they happen.

Jeffrey Weaver is a senior portfolio manager at Allspring Global Investments and heads the short-duration fixed-income, municipal and money markets teams. He believes it’s a good strategy to hold most investments for shorter periods until the next hike, then use money to lock in the rate.

“We’re reluctant to make significant purchases beyond March, which is when we expect the first rate hike. We get to take full advantage of the rate hike by staying short,” he said.

Or, alternatively, invest in debt that is priced in increases, such as maturing within one or two year.

“If the market begins to price in more rate hikes than we expect then we can take advantage of that and buy those longer securities,” Weaver added.

PIMCO’s Schneider said that investors may want to be more proactive and adopt strategies that span different short-term assets to generate returns. It may mean trading one’s own strategies over multiple short-term assets to generate returns, as opposed to investing in prime funds that could be subjected new regulatory restrictions.

“We look at this as a period of being much more constructive for cash investors than we saw in 2020 and largely 2021 when yields were near zero, but at the same time the opportunity set is to be active and be dynamic and yet be patient with how they’re thinking about managing liquidity,” he said.

This is especially so as inflation keeps reducing the return on fixed income assets. Even if inflation falls to 2%, yields will likely remain low.

The Fed’s last tightening cycle from 2015 to 2019 ended with large funding stresses as demand for overnight loans from companies, banks and other borrowers overwhelmed supply when the Fed reduced its balance sheet.

Since the Fed established last year a Standing Repo Facility as a permanent market backstop, it is unlikely that another cash crunch will occur. Any increase in the demand for this facility could be considered a warning sign.

An increase in use of the facility “would be a sign to the Fed that they need to slow down or stop reducing the size of the balance sheet,” said Tom Simons, a money market economist at Jefferies.

It will depend on the economic response to tightening. How fast the Fed’s balance card shrinks and how investors’ reliance upon its reverse repo facility decreases.