In a letter to shareholders in their latest Semi-Annual Report, American Funds President Kristine Nishiyama updated clients on the status of the $15.0 billion American Funds Money Market Fund given the looming money market fund reforms. The fund, while not officially a "government" money fund, meets current requirements for a Government MMF (80% in Govt securities). But it wouldn't meet the new requirements when they kick in in October 2016. So, between now and then, the firm has a decision to make on whether they go Government or not. Fidelity Investments, meanwhile, is already making the shift toward government securities in its $112 billion Fidelity Cash Reserves Fund (which will become the Government Cash Reserves Fund in October 2016), according to Barclays' Strategist Joseph Abate in his "US Weekly Money Market Update." Also, Fidelity released commentary in its "Insights and Outlook" series on government supply called, "Market Participants Remain Skeptical of Federal Open Market Committee Rate Forecast."
Nishiyama's letter, dated May 13, says, "As mentioned in our annual report, the SEC in July announced new rules governing money market funds. Government money market funds and retail prime money market funds will continue to maintain a stable NAV. However, institutional prime money market funds will be required to float their NAV, During times of stress, redemption gates and liquidity fees can be imposed on all non-government money market funds whether retail or institutional, at the discretion of the fund's board. Government money funds will be excluded from this requirement, but can opt in with proper notice to investors. American Funds Money Market Fund has historically invested between 85% and 90% of its assets in U.S. government securities, which is consistent with the previous SEC requirement of 80%. In order to qualify as a government money market fund, it must invest at least 99.5% of its assets in government securities, cash or repurchase agreements backed by government securities."
She comments, "We have reviewed the details of the rule and continue to evaluate options for the fund, including increasing the allocation of government securities to 99.5% in order to avoid the floating NAV, redemption gates, and liquidity fee requirements. The compliance date for these most significant changes to the rule is October 14, 2016. In the near future, we'll share with you how the fund will be managed going forward." (`Note: Our condolences to American Funds and the family of founder and fund industry giant Jim Rothenberg, Chairman of the Capital Group Companies, who passed away last week.)
Abate is seeing the shift to government already taking place in Fidelity Cash Reserves. In his weekly commentary, he writes, "In late January, Fidelity announced plans to convert several money funds to government-only status by the end of the year. The largest fund that will be converted held about $112bn in assets at the end of June -- unchanged from its January 31 level. Like other funds, this fund's WAM has been shrinking, although the decline (about 28%) is significantly larger than the industry average since January (15%)."
He continues, "But at the end of June, 51% of the fund's assets are invested in CP and CDs -- down from 65% at the end of January. At the same time, the fund has ramped up its holdings of government debt and repo -- from 15% to 31%. Thus, in aggregate the fund appears to have shifted roughly a quarter of its non-government holdings at the end of January into government-only eligible paper. Unsurprisingly, given the shortage of bills, the fund has met much of the demand for government paper with $10bn worth of repo from the Fed's RRP program."
Abate adds, "We expect the supply of bills to get even scarcer this fall as the Treasury negotiates around the debt ceiling. Although figures are still a bit murky and the exact timing is unclear, it is possible the Treasury might need to drain its cash buffer to retire $140bn or more in bills to create debt ceiling capacity to settle its late year coupon issuance. As a result, we expect that the fund's RRP holdings could climb to the full $30bn counterparty limit. But even then, the fund will still need to find $82bn in repo from dealers as well as bills."
Fidelity's Michael Morin, Director of Institutional Portfolio management, and Kerry Pope, Institutional Portfolio Manager, also discuss supply and demand issues in Fidelity's latest update. They write, "The Treasury has said that it will expand bill issuance to generate sufficient cash to cover one week's worth of outflows, to protect against a market disruption. This would suggest that the Treasury is seeking to increase bill issuance by an estimated $125 billion to $150 billion. However, this additional supply would be offset by the improvement in the budget deficit, which has lessened the Treasury's borrowing needs. Bill supply as a percentage of the Treasury's portfolio continues to be at a multi-decade low of approximately 11%, representing a decrease of more than $620 billion since the financial crisis peak in 2008."
They explain, "The supply of floating rate coupons and coupons rolling inside 397 days until maturity has provided a 4% increase in overall money market Treasury supply this year. A challenging supply-and-demand balance may be made even more difficult in the months ahead if the debt ceiling becomes an issue. Cuts to Treasury bill supply may be necessary should the Treasury exhaust its extraordinary measures and be forced to draw down its operating cash balance. While Congress could find a way to "kick the can down the road," the debt ceiling still presents a real risk to the already constrained market supply starting around October 2015."
Morin and Pope continue, "During the first half of the year, issuance of agency securities and repurchase agreements (repos) continued to contract -- a decrease of 7% and 3%, respectively. While this trend for agencies and repos is expected to continue, the growth in nonfinancial and foreign-financial commercial paper for the same period has helped to slow the downward supply trend—up 15% and 14%, respectively. The Fed announced plans to conduct term RRP operations during quarter-ends throughout 2015.... The early announcement of additional supply kept markets orderly during quarter-end."
On shortening WAMs, they write, "Fund weighted average maturities (WAMs) continued to trend lower, and our institutional prime funds ended June with WAMs at or less than 30 days. At the end of June, prime funds were positioned for a potential rate increase later in 2015 and potential redemptions in the second half of the year associated with regulatory reforms. Also, given the heightened demand for bills and agency discount notes, prime funds increased their holdings of short-dated time deposits to facilitate liquidity thresholds. Looking forward, government and Treasury funds could be more dependent on the Fed's RRP facility in the face of increasing demand and limited supply."
Finally, Fidelity adds, "For example, the seven-day term repo auction, which was introduced to help participants get over quarter-end, attracted $115 billion in bids, or just over $15 billion in oversubscriptions at the end of the second quarter, while the two-day term repo auction attracted more than $103 billion in bids, or just over $3 billion in oversubscriptions. The pricing on both auctions was 8 basis points, 3 basis points above the overnight RRP facility. Money market fund inflows may increase once market rates exceed administered rates. This rotation will assist banks in shedding a portion of the estimated $700 billion to $900 billion in excess deposits accumulated during the Fed's zero percent rate policy."
