In a recent "Market Memo" entitled, "Don't sweat the debt-ceiling showdown," Federated Investors' Senior Portfolio Manager Susan Hill writes, "It is likely that the game of chicken between Congress and the Obama administration over raising the debt ceiling will continue over the next several weeks, leading to market uncertainty and speculation about the prospects of a technical default by the Treasury. That's because raising the debt ceiling has become intertwined with the desire to make significant strides toward credible fiscal reform. But let's be clear. Federated considers the probability of a technical default by the Treasury to be virtually nonexistent."
She says, "We are confident that the debt ceiling will be raised by August 2nd, the date upon which the U.S. Department of the Treasury will have, according to Treasury Secretary Timothy Geithner, exhausted the extraordinary measures that it has at its disposal to meet the financial obligations of the federal government. Nevertheless, because there has been some market speculation as to what a technical default might mean to money market funds that hold Treasury securities, we wanted to address some of the basic questions surrounding this issue."
Hill explains, "First, the Securities and Exchange Commission Rule 2a-7 that governs money market funds does not require that a fund dispose of a security that is in default. Rather, it would permit the fund to continue to hold such a security, provided that the board of directors of the fund has determined that disposal of the security would not be in the best interests of the fund. Rule 2a-7 indicates that such determination may take into account, among other factors, market conditions that could affect the orderly disposition of the security. Given the expectation that any potential technical default on Treasury securities would be very short-lived, it is possible that a fund's board could make the determination to continue to hold the security."
She continues, "Second, although all short-term securities might exhibit some degree of volatility during this time, we would expect the market reaction to remain substantially below the threshold which might exert significant downward pressure on the net asset values (NAVs) of money market funds. All things being equal, it would take an instantaneous increase in rates on short-term securities of approximately 300 basis points before the NAV of a money market fund with a 60-day average maturity would be in jeopardy of breaking a buck. Such an extreme market overreaction is hard to imagine."
Hill says, "Finally, the Federated money market funds are absolutely committed to maintaining liquidity to meet the needs of their shareholders in the event that a fiscal reform package and subsequent increase in the debt ceiling is delayed. Rule 2a-7 already requires money market funds to maintain stringent minimum liquidity buffers for daily and weekly liquidity needs. Federated would expect to continuously evaluate the potential liquidity needs of its money market funds and augment their existing liquidity position with greater daily or weekly positions, cash balances or alternate liquidity sources should it appear necessary if the conflict continues."
Finally, Federated writes, "In other words, while we believe that political brinkmanship will give way to the hard realities that a failure to raise the debt ceiling would pose to the United States -- no one wins when systemic risk in the global financial markets is unleashed -- we are diligently working to prevent this showdown from undermining our primary goal: Providing clients with a stable source of cash management. When it comes to your money, we don't play games."
