We have stumbled upon a new trend that could be of interest. The amount of commercial paper and related “near cash” instruments held by Custodians could be a barometer of confidence and expectations of economic recovery. We have seen a quadrupling of inventory in these cash like instruments over the past 6 months.
Commercial paper (CP) and certificates of deposit (CDs) are very safe assets to own. They are issued by corporate who need to raise short term cash and they are sold at a slight discount to the value that they are redeemed at. They typically pay no interest. As such, they are low down on the list of attractive assets to own.
Securities lending has been an important market for commercial paper. The cash collateral that is received against the loans can be reinvested in money market funds and/or things like commercial paper. That has been the normal use case for CP for Custodians for some time.
So it is interesting to note that Custodian’s have seen an increase in their CP holdings over the last 6 months from $4bn to $12bn. It was last this high in Q1 2009 when confidence was extremely low. One guesses that the reason is the incredibly low yield from holding cash or T-Bills.
If you are a large asset manager and a transition in your portfolio results in a large amount of cash being held for a short period, what do you do if you want a very safe asset that pays some form of yield? The present answer seems to be CP. But, during the second half of last year, inventory in commercial paper was declining. This was presumably because the markets were strongly rebounding and many opportunities to house cash existed. That CP inventory is increasing again implies that the same opportunities no longer exist – interest rates are no different to this time last year when CP was declining so it can’t be merely due to the low interest rate environment.
However, commercial paper is not as safe as cash, especially since the Fed stopped its financing (guaranteeing) in February this year. Yet, the cessation of this quasi guarantee hasn’t stopped the increase in popularity of commercial paper. If we look at the graph of what we call “liquid assets” inventory (i.e commercial paper and certificates of deposit) the increase coincides with periods of stock market weakness and then it reduces when confidence returns. Today’s level has flattened out a little but the direction it takes from here could be a harbinger of things to come.
