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JP Morgan's latest "Short Term Fixed Income Strategy" comments on the Federal Reserve Bank of New York's recent expansion of Reverse Repo Counterparties (among other things). JPM says, "Regarding the Fed's normalization efforts, on January 16th the FRBNY announced the addition of 25 new counterparties eligible to participate in its reverse repo program (RRP). The additions included 7 banks, 6 GSEs (Farmer Mac along with 5 regional FHLBs), and 12 money market mutual funds -- 6 government funds, 4 prime funds, and 2 muni funds with a combined AuM of $131bn. All new counterparties are eligible to participate once operationally enabled, and are subject to the existing facility terms. In aggregate, we believe that these additions will increase demand for the RRP going forward. However, the magnitude of such increased demand remains unclear. As discussed in our previous note, banks historically have not been significant users of RRP, averaging less than 2% of daily usage since the facility's inception. Although GSEs have been larger users ... it is hard to gauge how much Farmer Mac and the 5 extra FHLBs will tap the facility, and the possible effects on the Fed Funds effective rate should they choose to use the RRP as a substitute to using the Fed Funds market. Finally, while the 12 new MMFs will certainly see the RRP as a source of supply, their usage capacity is relatively small compared to the existing MMF counterparties ($131bn vs. $2.1tn in AUM), and it is possible that they only have a marginal impact on demand. Furthermore, regardless of the effect on demand that the new counterparty additions may have, the Fed still has plenty of time to tweak other parameters of the RRP, with an additional year of testing pre-authorized. At some point throughout the course of the year, the Fed is likely to test higher rates, although it is unclear as to how much higher and when." See also, Citi's Andrew Hollenhorst on the Fed's RRP expansion. He comments, "Money funds (MMF) are the largest investors in the facility, averaging 85% of total cash in RRP. Each individual fund (rather than the fund family) counts as an RRP counterparty and the 12 new funds come from 9 fund families. (Figure 2) Of the 12 funds, 5 come from families that previously had no RRP eligible funds. According to regulatory filings the newly added MMF manage $137 billion or about 5% of total money fund assets." The new funds include: AllianceBernstein LP Government STIF Portfolio, Columbia Short-Term Cash Fund Prime, Dimensional Fund Advisors Short Term Investment Fund Prime, Fidelity Govt MMF, Goldman Sachs Financial Square Federal Fund, Financial Square Tax Free Fund, J.P. Morgan 100% UST MMF, Tax Free MMF, PFM Asset Management Prime, Reich & Tang Asset Management Daily Income Fund, SSgA Institutional US Govt MMF and US Treasury MMF.

Reuters writes "Bank-style regulation offered as temporary fix for money market funds". The article says, "Bank-style regulation of money market funds (MMFs) has been proposed as a temporary compromise as draft European Union rules for the trillion euro ($1.2 trillion) sector face the prospect of being blocked for a second time by European lawmakers. The rules proposed by the European Commission in Sept. 2013 aim to increase transparency and stability for MMFs, which are used by companies as an interest-earning cash deposit facility, but they have created deep splits among European Parliament members.... Lawmakers on the left want a tough regime including a fixed percentage of total capital being set aside to maintain stability, while parties on the right say that such measures would kill about half of Europe's MMF sector, thereby robbing the region's flagging economy of much-needed funds. The divisions raise doubts that consensus can be found before the European Parliament's economic affairs committee votes on the draft law for a second time next month, with a full parliamentary vote scheduled for March. The doubts prompted the European Commission, which often helps to broker deals on divisive rules, to suggest the compromise while lawmakers wrangle over the 800 amendments tabled so far." Reuters quotes Tilman Lueder, a "senior commission official dealing in investment funds policy," "We are slightly afraid that we are in need of a more immediate solution." But the piece creates confusion (since bank regulations would move away from compromise) by adding, "On balance, we see a lot of merit in some of the proposals to apply bank-like regulation (as an interim measure)."

Fitch Ratings writes in a statement entitled, "Fitch: Caution for Other LGIPs following Losses at IMET, "Reports of losses at the Illinois Metropolitan Investment Fund (IMET) due to potentially fraudulent investments highlights the importance of following industry best practices with respect to investment policies, controls, and strong oversight of third-party agents. It also underscores that standards vary across local government investment pools (LGIPs) and operational risks can be high." (See Crane Data's Jan. 9 News "Another Black Eye for LGIPs? Illinois Pool IMET Loses on Fake Repo".) Fitch explains, "IMET is an LGIP and manages investments on behalf of Illinois municipalities. The fund sought to manage itself in a manner similar to money market funds by seeking to maintain a stable net asset value. The LGIP disclosed it had more than $50.4 million invested in repurchase agreements issued by the First Farmers Financial that are now reported to be in default. Repos are regularly used by LGIPs to invest cash over a very short period of time. For rated pools, the repos typically are conducted with highly rated counterparties and collateralized by government or agency collateral in the event the counterparty defaults.... In this case, IMET reportedly relied on a third-party investment advisor, Pennant, to vet loans from First Farmer Financial. First Farmer Financial was an unrated counterparty, the repo agreement appears to have been bi-lateral without the benefit of a custodian and the collateral was somewhat esoteric -- private loans originated by First Farmers Financial and purported to carry a guaranteed by the U.S. Department of Agriculture. It now appears the loans did not carry a guarantee, undermining value as a secondary source of repayment. Generally speaking, LGIPs' first investment objective is safety and preservation of capital and investment guidelines and practices should be in line with this objective. The case of IMET raises questions about the pool's investment guidelines in relation to other rated pools. For example, are repo transactions with an unrated counterparty permissible and what types of collateral are eligible? IMET's case also begs the questions about policies with respect to bilateral repos where the collateral is not held by a recognized custodian and what oversight was performed by the investment team to review the repo collateral." In other news, ICI reported its weekly "Money Market Fund Assets <i:>`_," which says, "Total money market fund assets decreased by $970 million to $2.70 trillion for the week ended Wednesday, January 21, the Investment Company Institute reported today. Among taxable money market funds, Treasury funds (including agency and repo) increased by $610 million and prime funds decreased by $2.18 billion. Tax-exempt money market funds increased by $600 million."

A recent bulletin entitled, "Citi Agency & Trust North America Conventional Debt: 2014 in Review" gives a brief update on the commercial paper and CD marketplaces. (Note: Citi's Rob Crowe and Jean-Luc Sinniger are scheduled to give an update on the CP market at our Money Fund University, which takes place Thursday and Friday in Stamford, Conn. The CPIWG's Marian Trano will also speak on the CD market.) Citi's update reads, "In 2014, Citi Agency & Trust reached many key milestones, including supporting a record level of USD 500b in CP and CD debt outstanding and increasing our CP market share year-over-year by 10% to 32%.... During the year, we continued our commitment in the Commercial Paper Issuer's Working Group and [SIFMA].... As a key provider of IPA services, we continually monitor trends for money market instruments and corporate debt.... Market highlight ... include: At year-end 2014, U.S. CP outstanding was USD 930.4b, slightly down from the year-end 2013 amount of USD 951.6b, according to the Federal Reserve Board. Key market movements included: Financial CP outstanding decreased approximately 4% from year-end 2013 to year-end 2014, primarily due to a 7% decrease in domestic Financial CP and a 2% decrease in foreign Financial CP. Certificates of Deposit increased 4% year-over-year to USD 947.9b at year-end 2014. Non-financial CP outstanding increased by approximately 16% from year-end 2013 to year-end 2014, with a 26% increase in domestic Non-financial CP and a 13% decrease in foreign Non-financial CP. Asset Backed CP outstanding fell approximately 12% for the same period, although it slightly exceeded Non-financial CP outstanding throughout Q1 2014, and in June and December." In other news, The Wall Street Journal writes, "Fed Officials on Track to Raise Short-Term Rates Later in the Year." It says, "Federal Reserve officials are staying on track to start raising short-term interest rates later this year, even though long-term rates are going in the other direction amid new investor worries about weak global growth, falling oil prices and slowing consumer price inflation."

Money market fund fee waivers hit a record in 2014, reports mutual fund industry publication ignites in a story, "Darkness Before the Dawn: Money Fund Waivers Hit $6.3B." The article says, "`Money market fund fee waivers climbed to their highest-ever levels in 2014, hitting $6.3 billion. That's up from $5.8 billion in 2013 and $4.8 billion in 2012, according to data from Investment Company Institute and iMoneyNet. Total money fund assets also grew, partly accounting for the waivers. A bump of about $48 billion during the year pushed industrywide assets to $2.75 trillion in December, data from iMoneyNet shows. "Hopefully this is the darkness before the dawn," says Peter Crane, CEO of Crane Data, referring to an expected increase in interest rates this year that would lift money fund yields. Since the Federal Reserve lowered its interest rate target to near zero in 2008, many firms have put in place fee waivers to simply keep yields positive. In fact, 99% of money fund share classes waived fees as of the end of December, whereas only 64% of share classes did so in January 2008, ICI and iMoneyNet data show. "If rates start moving higher this year, the recovery will start. You get a couple [Federal Reserve] hikes and happy days will be here again for the money fund business," says Crane. Investors stuck with money funds in 2014 despite ultra-low yields, notes Sean Collins, senior director of industry and financial research at ICI. The average seven-day gross yield on money funds at the end of December was 0.13%. After fees, the average seven-day yield was 0.02%, according to Crane Data. The average expense ratio for money funds was 0.12% in the third quarter, on an asset-weighted basis, down from 0.13% in the prior-year period, iMoneyNet reported. "Clearly the vast majority of gross yields were going to pay fees," says Crane, adding that it appears most firms have been able to cover expenses. Still, lower yields have meant lower profits. Schwab's fee waivers have climbed in recent years, mirroring those of the broader industry. The firm waived a record $751 million in fees in 2014, up from $674 million in 2013 and $587 million in 2012, according to regulatory filings.... Meanwhile, Federated reported waiving $89 million in money fund fees for the first three quarters of 2014.... The firm reports fourth-quarter results on Jan. 22. Federated was the fourth-largest manager of money funds, with $215 billion in assets as of Dec. 31, according to Crane Data. Schwab manages mostly retail money funds, which generally carry higher fees than institutional funds, resulting in bigger waivers.... "The fee waivers are clearly hitting higher expense and retail money market funds harder than institutional," says Crane. "It varies depending on how managers distribute their funds. Sometimes the intermediaries are sharing, or bearing the brunt, of the pain, and sometimes the manager is bearing the brunt.""

Citi Strategist Vikram Rai writes "2015: Are We Crying Wolf Again?" in his latest "Short Duration Strategy" piece. He says, "At the start of 2014, a forecast for higher rates was the consensus view among market experts though there was significant dispersion with respect to views on the timing of the Fed's first rate hike. This year, at first blush, it seems like there is less consensus among strategists across the Street regarding either the level of rates or the timing of the first rate hike -- i.e. the dispersion in views has actually increased vs. last year! Some market experts are forecasting hikes to the tune of 100–150bp in 2015. Citi economists expect the Fed to increase policy rates by only 25-50bp in 2015 though the lift-off date may be mid-2015 or later depending on economic conditions. Citi does believe that the Fed will begin hiking rates this year though we are also of the view that the upcoming hiking cycle will be different from prior cycles. This is because financial market conditions will play a much more important factor in the pace of Fed rate hikes this time around vs. 2004-2007, when the Fed tightened almost continuously in 17, 25bp increments to bring the Fed rate to 5.25% from 1%." It continues, "Even with higher market rates, it is unlikely that focus for cash investors will shift to yield from liquidity and asset preservation. But roughly $1.4TR has moved into non-interest bearing bank accounts since 2008 and with higher market rates, we expect that depositors will be less willing to leave cash with large banks at zero rates. Historical data shows increased flows into MMFs after rate hikes though these flows typically lag the hikes.... [W]e expect that in the short term larger banks may actually be relieved to see some cash leave their balance sheet and are unlikely to compete with money funds by increasing their deposit rates. While money market reform has reduced the appeal of institutional prime funds, so far we see little evidence of large outflows though this could change as we approach compliance date." Citi's Andrew Hollenhorst also writes "Will Short Rates Stay Elevated?" in recent commentary, saying, "As we approached year end, we expected the temporary increase in the Fed's ON reverse repo (RRP) rate and the availability of $300 billion in Fed term reverse repo to keep rates somewhat elevated. Even so, we were surprised at how supported rates remained coming into year end. Perhaps more surprising is the fact that short-term rates including 3m LIBOR, Fed effective and repo have remained high even as we have moved into the new year."

Money fund assets have started 2015 on a downward path after rising for 4 straight months to end 2014. ICI's latest weekly "`Money Market Fund Assets," shows that assets decreased last week for the second week in a row. It says, "Total money market fund assets decreased by $9.03 billion to $2.71 trillion for the week ended Wednesday, January 14, the Investment Company Institute reported today. Among taxable money market funds, Treasury funds (including agency and repo) increased by $890 million and prime funds decreased by $7.47 billion. Tax-exempt money market funds decreased by $2.46 billion. Assets of retail money market funds decreased by $6.57 billion to $909.42 billion. Among retail funds, Treasury money market fund assets decreased by $920 million to $197.82 billion, prime money market fund assets decreased by $4.26 billion to $520.17 billion, and tax-exempt fund assets decreased by $1.39 billion to $191.44 billion. Assets of institutional money market funds decreased by $2.47 billion to $1.80 trillion. Among institutional funds, Treasury money market fund assets increased by $1.81 billion to $793.71 billion, prime money market fund assets decreased by $3.21 billion to $930.17 billion, and tax-exempt fund assets decreased by $1.07 billion to $72.00 billion." In other news, the Financial Times writes, "Record Cash Flow into EU Money Funds." The piece says, "Investors seeking to escape Europe's economic uncertainty have stashed a record amount of cash into ultraconservative investment funds in spite of many paying zero or even negative interest rates. European money market funds, which act as important sources of short-term finance for companies and banks worldwide, registered a record $27bn in net inflows so far this year, compared with the previous record of $24.3bn for the entire month of January in 2013, according to data from EPFR Global. The flows come even though the E1tn eurozone money market industry is in effect charging investors to park their cash with it.... Last year European money market funds attracted $40bn in net inflows. The decline into negative territory for money market funds followed the decision by the ECB in June to cut its deposit rate below zero -- the first central bank in the world to take such action. The ECB action had the effect of penalising banks that wanted to park their spare cash at the central bank in the hope they would use it to boost lending instead."

Bloomberg writes "No relief as shrinking repo leaves bonds exposed", which says, "While the biggest part of the market for repurchase agreements has decreased 18.5 percent over the past two years, banks aren't yet done complying with regulations that are forcing them to cut back in this area, say analysts at firms from Citigroup to Nomura Holdings. Dealers and investors report seeing declines in liquidity in times of market stress, including wider gaps between bid and offer prices and more difficulty in completing trades.... Securities dealers use repurchase, or repo, agreements to finance their holdings and leverage their potential gains. One party offers a security as collateral to borrow cash for a period as short as a day. Money-market mutual funds are among the biggest lenders of cash in those deals, using the agreements as safe, short-term liquid investments. The amount of securities financed through one part of the market known as tri-party repo fell to an average $1.64 trillion as of Dec. 9, from $1.96 trillion two years earlier, according to data compiled by the Federal Reserve from the primary dealers. The market's now a little more than half of the $2.8 trillion that was being financed daily during its peak in 2008, before the credit seizure that sent investors fleeing and caused the collapse of Lehman Brothers Holdings Inc." Bloomberg's piece adds, "While U.S. financial institutions have already taken significant steps in reducing their balance sheets to comply with capital requirements and the risk-curbing rules of the Dodd-Frank Act, banks overseas have further to go, said Andrew Hollenhorst, a fixed-income strategist at Citigroup in New York." Bloomberg's Businessweek also writes, "Fed Funds Rate Increase Path Expectations Tumble in Money Market." It comments, "Traders of money-market securities are slashing their expectations for the extent of Federal Reserve interest rate increases for the end of this year. Interest-rate derivatives predict the Fed's policy rate will rise to about 0.41 percent by the end December, about a third of the 1.125 percent rate central bank officials predicted in December.... Fed fund future contracts see a greater than 50 percent chance of the first central bank rate increase won't happen until the final quarter of 2015.... "Money markets have pushed out the timing of the start of the Fed's lift off," said Brian Smedley, an interest-rate strategist at Bank of America Corp. in New York. "Now it's looking at it taking place in the fourth quarter."" The piece add, "The federal funds futures market see overnight rates moving to 1.1 percent by the end of 2016, which compares to a 2.5 percent median estimate in the Fed's quarterly forecasts."

Wells Fargo Advantage Money Market Funds also issued its latest "Portfolio Manager Commentary," earlier this week, the first under the leadership of Laurie White, who takes over for the retiring Dave Sylvester. Wells PMs review the major stories of 2014 in their Commentary, and add, "[T]he credit environment was an oasis of calm during the year. As we get further from the depths of the financial crisis, it is clear that balance sheets in general have begun to heal and the financial conditions of many entities have greatly improved. The credit environment is so changed, in fact, that when December brought news of another political crisis in Greece and renewed speculation it would leave the eurozone, short-term markets did not even blink, and the story barely even made the news cycle! ... U.S. government money market rates were amazingly stable this year, with no significant credit or political events such as a European debt crisis or U.S. debt ceiling showdown to drag rates temporarily out of their near-zero malaise. Only in December did rates stray from their ranges for reasons discussed below. There were three main themes during the year and, while we have frequently discussed them in these commentaries, they continue to drive the market. First, although we've trumpeted the likely negative effects on short-term interest rates due to various banking regulations, the regulations, such as those addressing liquidity and leverage, have proven to constrain supply and spur demand perhaps even more than we envisioned. The demand for Treasury securities maturing in fewer than three months has kept their yields near zero even when other government rates, such as those for repo and discount notes, have risen. In addition, "free-market" repo supply -- that is, repo not executed with the Fed -- continues to shrink, especially on reporting dates such as month- and quarter-ends. When outsized demand meets dwindling supply, yields fall, even if authorities want them to rise. This brings us to the second main theme of 2014, which is the Fed's impact on the money markets through the evolving testing of its RRP program.... The third theme of 2014, the chance of the Fed raising interest rates, lurked beneath the surface most of the year, present though little seen, until it bubbled up with a strong December payroll report on December 5." Wells adds, "Similarly to the government markets, the two main themes this year in the prime markets continue to be a limited selection of high-quality assets and persistently low interest rates."

Reuters writes, "Big Banks Park Beat-up Energy Sector Bonds in U.S. Money Funds. The outrageous piece, which relies on ancient portfolio holdings data, says, "Big European and American banks have found a productive place to park the energy sector's most distressed debt: the $2.7 trillion U.S. money market industry. Barclays Bank plc, Credit Suisse and Wells Fargo and others get overnight and short-term loans from companies that run money market mutual funds such as Fidelity Investments, BlackRock Inc, American Beacon and others. The banks use the money to fund long positions in securities or to cover short positions. For collateral, the funds are accepting the junk-rated bonds of beat-up energy companies. Even though the value of the bonds are in free fall as oil prices plummet, the money funds readily accept the debt, because it's a way to generate above-market yields in an industry hurt by near-zero interest rates." [Note: There is no evidence that any money funds currently are holding any "junk-rated bonds of beat-up energy companies; Crane Data's latest portfolio holdings reports show no such thing.] Reuters explains, "In 2014, the average yield for taxable money fund investors was a paltry 0.01 percent. Banks currently have about $90 billion outstanding in short-term and overnight loans backed by riskier assets that include corporate debt and equities. The exact amount of junk-rated energy debt used as collateral was not available. But more than a dozen of the sector's mostly highly distressed issuers, including QuickSilver Resources, Black Elk Energy, Halcon Resources, Samson Investment and Sidewinder Drilling Inc, have had their bonds used as collateral, according to recent fund disclosures [sic]." It continues, "`These so-called "other repurchase agreements" generate above-market yields for the funds, ranging anywhere from 20 basis points to 50 basis points. In contrast, repo loans backed by safe U.S. Treasuries can generate yields of about 10 basis points and less, according to recent fund disclosures.... Money funds downplay the risk in the repo transactions backed by the junk-rated collateral. They say their ultimate backstop is the bank on the other side of the deal."

Barclays' strategist Joseph Abate writes in his latest "Money Market Update," "This week the FOMC announced plans to extend its testing of the overnight RRP program for another year. At the same time, it shelved plans to develop an alternative monetary policy tool - the segregated cash account (SCA)." On the SCA he writes, "The Fed's latest tool had a very brief and not so wondrous life. The SCA drew considerable market attention after a vague two-sentence mention in last October's FOMC minutes. As we understood the proposal, investors would be able to open a bank account that was collateralized by an equal amount of bank reserves maintained at a segregated account at the Federal Reserve. The SCA would effectively enable depositors – through the intermediation of a willing bank – to earn IOER. The bank and the depositor would share the interest earned on their reserve balance at the Fed. Strong demand for these accounts would be necessary to drain the $2trn or so in bank reserves needed to create torque under the effective fed funds rate. But the SCA would have faced a number of regulatory and practical challenges.... Less than 2m after making its first official FOMC appearance, the SCA proposal has been sidelined." Abate also comments, "However, the Fed may not need the SCA or any additional tools. This week, the FOMC announced plans to extend testing of the overnight RRP program for another year (through January 29, 2016). Under the terms of the extension, the overnight offering rate range will remain at 0-5bp and the daily operation cap and counterparty limit will stay at $300bn and $30bn, respectively. As written, the language provides authorization for overnight operations only. Recall that the FOMC sets these parameters, giving the New York Fed permission to change the offering rate within the pre-established range subject to approval from Fed Chair Janet Yellen."

The ICI announced that it is hosting a workshop on February 4 entitled, "Will You Be Ready? Implementing the New Money Market Fund Rules," which will prep money fund managers on the SEC reforms. The notice says, "Please join the Investment Company Institute on February 4, 2015, at the Marriott Wardman Park in Washington, DC, for a one-day conference exploring the legal, operational, and board considerations associated with the U.S. Securities and Exchange Commission's 2014 money market fund rules. "Will You Be Ready? Implementing the New Money Market Fund Rules" will bring together money market fund practitioners and representatives from the SEC for an in-depth discussion and exchange of ideas on the implications of the new rules. Conference attendees will: Hear about the legal and interpretive issues of the new rules; Learn about the operational considerations and challenges facing the industry; Gain insight about new fund board responsibilities; Learn about the new money market fund disclosure requirements; Be eligible for CLE/CPE credit." Registration fees are $650 for members, $850 for nonmembers, $350 for independent directors, and $350 government rate. Also, ICI's latest weekly "Money Market Fund Assets," says, "Total money market fund assets decreased by $18.59 billion to $2.71 trillion for the eight-day period ended Wednesday, January 7.... Among taxable money market funds, Treasury funds (including agency and repo) decreased by $23.12 billion and prime funds decreased by $270 million. Tax-exempt money market funds increased by $4.80 billion. Assets of retail money market funds increased by $4.66 billion to $915.96 billion.... Assets of institutional money market funds decreased by $23.25 billion to $1.80 trillion. Among institutional funds, Treasury money market fund assets decreased by $22.00 billion to $791.91 billion, prime money market fund assets decreased by $3.53 billion to $933.37 billion, and tax-exempt fund assets increased by $2.29 billion to $73.07 billion."

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