Three papers released last week address three of the biggest questions in the money markets of late -- cash investor concerns, demand for Prime MMFs, and, a surprise new arrival (or revival), negative yields. Fitch Ratings' published, "Yields, Counterparty Risk Fuel Angst for Treasurers," which surveys corporate treasurers on their biggest cash investing challenges. Moody's Investors Service wrote, "Higher Yields and Rising Investor Anxiety Support Demand for Large US Prime MMFs," which looks at the possibility of Prime outflows. And, finally, BofA Merrill Lynch released commentary on "Negative Rates in the US." We excerpt from and summarize the three reports below.
On the possibility and implications of negative rates in the U.S., BofA's Mark Cabana writes, "With other major central banks adopting negative rates, discussion has recently shifted to whether the Fed would consider a similar policy. While not our baseline scenario, if the US economy were to sufficiently weaken we believe the Fed could consider negative rates as a means to ease policy.... To implement negative interest rates, the Fed could potentially utilize the overnight reverse repo facility (ON RRP) and interest rates on excess reserves (IOER)."
Cabana says, "Adopting a negative rate policy could result in charges on institutional or nonoperational bank deposits and increase the risk that charges get passed along to a broader set of depositors. Such a policy would also create operating challenges for money market mutual funds, where they might need initiate customer fees, operate at a loss, or close their funds. In addition, negative rates would likely necessitate changes to US Treasury Department auction systems to issue bills and nominal coupons at prices above par. Unproductive shifts in savings and payment behavior could also result from a prolonged period of deeply negative interest rates."
He adds, "Another complication of negative rates is the $3 trillion money fund industry and its ability to operate in such an environment.... To deal with low returns, money funds could consider charging customers, reducing management fees, seeking subsidies from fund sponsors, or closing their doors.... Although negative rates have posed challenges for the $1.15 trillion (E1.04 trillion) in European money funds, the industry has adapted.... [S]ome European money funds employ "reverse stock splits" or "reverse exchange mechanisms" where outstanding shares in the fund are gradually reduced to reflect the negative yield. Some European funds have also applied explicit customer charges.... `U.S. money funds might consider applying similar mechanisms in a negative rate environment."
Note: Crane Data has been asked about negative yields and European money funds a number of times this week. For more information, see the following Crane Data News articles in our Archives: "FT on Negative Rates in Europe" (11/28/14), "Northern's New Euro VNAV MMF" (11/6/14), "Moody's on Negative Yields, Euro MFs" (11/3/14), "BlackRock Activates "Reverse Distribution Mechanism" on Euro Govt MF" (9/15/14), "Moody's Reviews Euro Money Fund Preparations for Negative Yields" (3/15/13), "World Turned Upside Down: JPM Flex Class For Negative Euro Rates" (10/19/12), "Moody's on JPM Euro Liquidity Funds' Launch of Flex Distributing Class" (11/21/12), "More on Ultra-Low Treasury Rates, Fee Waivers and Negative Yields" (1/7/09), "Federal Reserve Cuts Target to Zero; Can Money Market Funds Survive?" (12/16/08), and "Video: "Crane Says Money Fund Yields May Fall to Less Than Zero"" (12/11/08).
Fitch's survey piece asks, What issues are keeping corporate treasurers up at night? Authors Roger Merritt, Alastair Sewell and Charlotte Quiniou write, "Corporate treasurers face numerous headwinds in investing cash and funding their balance sheets, many brought on by post-crisis regulatory initiatives. In terms of investing cash, low yields remain the number one concern for treasurers in a recent Fitch survey. For those managing cash in the U.S., the recent 'lift off' by the Federal Reserve may help somewhat, but no relief is in sight for Euro investors where yields are decidedly negative."
They continue, "Somewhat surprisingly, regulations (money fund reform and Basel III) have taken a back seat in recent months among corporate treasurers' cash investing challenges. Why? Because counterparty risk has emerged as a primary concern for treasurers, placing second in a recent survey conducted by Fitch." According to the survey, 80% cited low yields as the biggest cash investing challenge, while about 60% said counterparty risk, and 55% said Basel 3 Banking regulations. Just under 40% said money fund regulations, while around 25% said supply, and 20% said trapped cash.
Fitch says, "On the topic of money market fund reform, corporate treasurers are most concerned with how yields will be affected, the requirement that U.S. institutional prime money funds implement fees & gates, and the difficulties they are likely to face in adapting to this new environment. In fact, the liquidity fees & gates prospect is proving to be quite a large hurdle for treasurers who need ready access to operational cash to fund their business." The survey found that 55% said impact on yields was the number one reform-related concern, followed by fees and gates at 51% and operational at 50%. Intraday was around 40%, while the floating NAV was well down the list at 35%.
The data also revealed treasurers likelihood of remaining in Prime, writing, "In fact, roughly 55% of treasurers that Fitch surveyed said their allocations to institutional prime money market funds would stay the same or go up once these funds switch to floating NAV. This indicates that some modest exposure to mark-to-market pricing is not an overarching concern. Having access to liquidity on an intra-day basis also appears to be an important feature of money funds that many treasurers are seeking to retain." The survey said 45% would stay the same, 10% would increase Prime Inst allocations, 24% would decrease, and 21% would eliminate altogether.
Fitch continues, "Many corporate treasurers still hold large amounts of "back-up" cash on balance sheet in case market conditions change. A sizeable number of these treasurers also do not segment their cash into so-called liquidity buckets, which could help generate more yield by giving up some liquidity. Why is this? Until now, money funds have been the ideal vehicle to meet liquidity needs, providing cash managers with a "free lunch" of yield, liquidity and preservation of capital. However, looming market changes means the free lunch is over and the cost of same-day liquidity will go up. It will be instructive over time as corporate treasurers come to terms with the new, more challenging cash management paradigm whether they become more open to cash segmentation."
Finally, Moody's report estimates that Prime Inst outflows could exceed 25%. It states, "Prevailing risk-off sentiment will keep investors in money market funds. Although total US prime money market fund assets contracted in 4Q 2015 owing to previously announced prime to government fund conversions, asset levels in the 10 largest Moody's rated US prime funds rose 4% to $443 billion. Higher yields on prime money market funds following the Fed's December rate increase -- along with waning investor risk appetites -- should sustain demand for cash investments in 1Q 2016. That said, investor demand for prime money market funds will likely reverse in the second and third quarters of 2016 ahead of the implementation of new money fund reforms in October. Investor-directed outflows are likely to be lumpy, since money fund investors tend to act together, and could exceed 25% of institutional prime fund assets."
It adds, "Prime fund managers shortened WAMs to their lowest levels in a year in 4Q 2015 in anticipation of a December Fed action. However, with year-end behind us and the potential for market instability to slow the pace of Fed rate increases, we expect prime money market funds to extend WAMs in 1Q 2016. We expect prime fund managers to seek yield opportunities through increasing investment in longer-tenor securities.... Liquidity profiles of US prime funds strengthened in 4Q 2015, with 38% of assets maturing overnight (also includes US Treasuries with 18 months or less to maturity) at December month-end, up from 28% at September month-end."
