(Bloomberg) — The greatest monetary-easing cycle in the history of the U.S. has left a mind-boggling amount of cash floating around in the economy. Banks hold $2.5 trillion in excess reserves — money they essentially don't know what to do with — at the Federal Reserve.
So as the Fed prepares to raise interest rates from near zero as soon as next week, bond investors are on edge. Beyond all the "is-this-the-right-move" questions that surround every increase, there's a logistical concern: With so much cash sloshing around, will Fed officials be able to nudge rates as high as they want? Will the new-fangled tools they've created to engineer the move work, or instead sow the kind of confusion that can dent the Fed's credibility and spur a broader market selloff?
Many investors are taking no chances.
They're piling into the safest, most liquid securities available, or those that move them as far away from the epicenter of the U.S. financial system as possible. James Camp at Eagle Asset Management is buying Treasuries and unloading debt linked to credit, such as corporate bonds. Peter Yi, director of short-term fixed income at Northern Trust Corp. is stockpiling cash. Jerome Schneider, head of short-term strategies at Pacific Investment Management Co., is diversifying into securities such as debt in foreign currencies. In a sign of the search for liquidity, U.S. money funds have cut the average maturity of their assets to the lowest since 2006.
"You just stay away from this one," said Camp, director of fixed-income at Eagle Asset, which manages $30.6 billion in St. Petersburg, Florida. "You just let this play out. It's OK to wait and see, and see how risk markets react. I love Treasuries here."
In the lead-up to the Fed decision, investors are the most bullish on Treasuries since 2013, according to a JPMorgan Chase & Co. survey of clients on Monday. A rout last week that drove two-year yields to a five-year high helped lure buyers anticipating that the Fed will stick to a gradual pace of rate increases. Wall Street's consensus is that the Fed will lift its target by a quarter-percentage point on Dec. 16, to a range of 0.25 percent to 0.5 percent.
Camp boosted Treasuries holdings by 20 percent in the last six months, most recently adding seven- to 10-year maturities. He sees government debt offering shelter in case the Fed's tightening leads investors to shun riskier assets, such as high- yield securities, and prefers longer maturities that would be less influenced by turbulence in shorter-dated obligations.
'Be prudent'
Yi at Chicago-based Northern Trust, which manages $946 billion, has cash and securities maturing within five days as much as 15 percent above levels of prior years in the short-term funds he oversees. He's focused on boosting holdings that are easy to sell in the event he faces withdrawals.
"We need to be prudent about any interest-rate exposure," said Pimco's Schneider, who manages about $250 billion of short- term assets at the Newport Beach, California-based firm. "We're looking for ways to diversify our liquidity risk in high-quality assets, and doing so with the view that rates are going higher."
At issue is the Fed's balance sheet, which ballooned as it bought bonds to pump cash into the economy and support faltering growth. Policy makers need new methods to drain that money and push rates higher in an interbank lending market, known as fed funds, that has become harder to influence now that cash-heavy banks rely on it infrequently.
Some investors see the volatility around the Fed liftoff as a temporary disturbance with a limited ripple effect during the year-end period.
