In an historic move, the Governing Council of the European Central Bank cut the interest rate on the deposit facility to -0.10%, effective June 11, 2014. It's a record-low rate for the ECB and the first time a major central bank has set a negative rate. In its FAQ explaining the move, the ECB writes, "Like most central banks, the ECB influences inflation by setting interest rates. If the central bank wants to act against too high inflation, it generally increases interest rates, making it more expensive to borrow and more attractive to save. By contrast, if it wants to counter too low inflation, it reduces interest rates. Since euro area inflation is expected to remain considerably below 2% for a prolonged period, the ECB's Governing Council has judged that it needs to lower interest rates. The ECB has three main interest rates on which it can act: the marginal lending facility for overnight lending to banks, the main refinancing operations and the deposit facility. The main refinancing rate is the rate at which banks can regularly borrow from the ECB while the deposit rate is the rate banks receive for funds parked at the central bank. All three rates have been lowered." Below, we discuss the move and its potential impact on Euro money market funds and indirectly on U.S. MMFs and European USD money market funds.
The ECB adds, "To maintain a functioning money market in which commercial banks lend to each other, these rates cannot be too close to each other. Since the deposit rate was already at 0% and the refinancing rate at 0.25%, a cut in the refinancing rate to 0.15% meant the deposit rate was lowered to −0.10% to maintain this corridor. The cut is part of a combination of measures designed to ensure price stability over the medium term, which is a necessary condition for sustainable growth in the euro area."
In a press conference following the announcement, ECB President Mario Draghi talked about the impact on money markets. On the transcript posted by Bloomberg BusinessWeek, Draghi says, "Interest rates will stay low for long, possibly longer than previously foreseen, and this will feed into the money market conditions via the yield curves and the exchange rate. This is the first block. The second is; we want to make sure that these improved conditions in the money markets would be transmitted to the real economy.... When do we foresee we'll see some outcome? It's very difficult to say, but most likely it will -- we'll all see immediate effects on the money markets and we will see delayed effects on the real economy attributable to this."
Fitch Ratings comments, "Euro-denominated money market funds have already taken investment and operational measures to prepare for yields declining or even turning negative, should short-term money market rates shift in that direction following the European Central Bank's decision to cut the rate on its deposit facility to minus 10bp. [Last week's] ECB negative deposit rate move and cut in the main refinancing rate of 10bp to 0.15%, effective 11 June, is likely to push MMF yields back to near zero levels. MMF net yields had ticked up to reach 18bp on average at end-May across euro CNAV MMFs, from a trough in February 2013 at 2bp."
Fitch continues, "The cut in the ECB's deposit rate will push the Euro overnight index average lower, but the risk of MMF yields turning negative is lower now than 18 months ago, when the eurozone liquidity was under stress. Current market rate levels means that most MMFs do not anticipate difficulties placing short-term cash.... It is unknown how investors will react to the likely decline of MMF yields in the current less risk-averse market environment. They may elect to switch to higher yielding products, trading off liquidity, spread sensitivity and credit quality for higher yields."
A Reuters article entitled, "Further ECB easing to have little to no money market impact: poll", says the rate change would little or no impact on money market funds. "Another cut to the ECB's deposit rate, currently at zero, would effectively charge banks to park cash with it overnight but a slim majority of euro money market traders -- 13 of 23 -- said the package would only lower near-term money market rates slightly. The other 10 traders said further policy easing by the ECB on Thursday would not do anything to money market rates even in the near term."
However, a Reuters article, "Euro holds ground even as ECB launches low inflation fight," published June 5, says it could lead to an exodus. "Morgan Stanley analysts reckon the imposition of negative rates could lead to an exodus from euro zone money markets. They expect U.S. money market funds, who have holdings of around 350 billion euros in the euro zone, to liquidate some of their holdings, putting downward pressure on the euro." [Note: we're mystified by this speculation and don't see how Euro rates would impact U.S. money funds, which can only buy US dollar-denominated debt, at all.]
Crane Data has reported on several examples of consolidation in the European money market space in recent months. In an article from October 2013, we reported "Goldman Sachs AM to Acquire RBS' Offshore Money Funds Business," and in August 2012, we wrote "BofA to Close and Liquidate Global Liquidity Euro Money Fund." BofA said at the time, "The decision to close the Euro Fund follows the European Central Bank's July 5th [2012] rate cut, which reduced its benchmark interest rate to a record low of 0.75% and the rate on overnight deposits to 0.00%. The resulting yield pressure on Euro-denominated short term debt makes it difficult to manage the Euro Fund within its investment guidelines without having a negative effect on the value and yield of the Euro Fund." Finally, we wrote that "PIMCO liquidated its Euro Liquidity Fund" in October 2012.
While we expect this modest consolidation to continue, we don't expect any drastic change in the trend of the slow and gradual decline in Euro money market fund assets. Crane Data's Money Fund Intelligence International, which tracks the Dublin and Luxembourg-domiciled "offshore" money fund market, tracks 24 managers overseeing $698 billion in assets, with $388 billion in US dollar funds, L125 billion in Pound Sterling funds, and just E78 billion in Euro funds, and as of June 4, 2014. Our Crane EUR MMF Index currently shows the average 7-Day Yield of the 98 Euro funds we track at 0.12%, much higher than the Crane USD MMF Index, which yields just 0.03%. (So the Euro yields still have room to drop before fee waivers and other measures set in to keep them from going negative.)
