The Financial Times featured the article, "Gush of cash into money market funds tipped to continue in 2024," which tells us, "Money market fund managers see no end in sight to the record inflows they have garnered in 2023, as cash continues to pour in from investors hoping to take advantage of the highest yields available in years. Almost $1.19tn has flooded into US money market funds since January 1, according to flow tracker EPFR, fueled by the Federal Reserve's aggressive campaign of interest rate rises. That is a far cry from negligible inflows in 2022 and well above the average full-year net inflow figure of $179bn for 2012-2022." (Note: Register ASAP for our Money Fund University, Dec. 18-19 in Jersey City, New Jersey, at the Westin Jersey City Newport. Clients and friends are also welcome to stop by Crane Data's Holiday Cocktail Party at MFU on 12/18 from 5-7:30pm!)
The piece explains, "More than $257bn poured in between October 31 and November 30 alone, according to the latest available data -- the biggest monthly inflow since banking ructions in March sparked a flight from ordinary deposit accounts. Those inflows have persisted even as markets are pricing in bets that the Fed will not raise interest rates again this cycle, and will cut borrowing costs as soon as the spring."
The FT says, "Money market fund assets hit an all-time high of $5.8tn last week (Nov 29), as investors continue to harbour doubts about long dated debt. Now, major fund houses including Goldman Sachs and Federated Hermes are predicting that the torrent will carry through to 2024, fueled by institutional investors trying to lock in returns as interest rates stabilise, and before the Fed starts to cut."
They quote Federated Hermes' CEO Chris Donahue, "I'm not looking at a big spring back.... It's more likely they're going to get another trillion in than there's going to [be] a trillion out. If we're right that these rates are going to be here longer term, and that is the way it's going to be for a while ... then you're going to get paid for being in the money fund."
The article continues, "Much of this year's cascade into money market funds in the US has been driven by retail investors rather than corporate treasurers, mutual funds and insurance companies. The latter typically invests directly in Treasury bills and other short-dated debt instruments as interest rates are on the way up, because they can capture the rise in yields more immediately. But that changes, 'once the Fed stops and goes on a pause, and that interest rate has levelled out ... then institutional investors are attracted to money market funds, because they do have the same yield as the underlying short-term instruments [and] they offer a lot of diversification for institutional investors,' said Shelly Antoniewicz, ICI's deputy chief economist."
It also quotes Shaun Cullinan, global head of liquidity solutions at Goldman Sachs, "You typically find that as the easing cycle begins ... it's very likely that the yield on money market funds will exceed the yield on the direct market investments.... You can see institutional investors pivoting into funds to achieve that higher return, because those funds have some embedded duration in them."
The FT adds, "Cullinan said that 'the trillion that came in this year was surprising -- so we could certainly be surprised again next year.' While the Fed has not suggested it intends to cut interest rates anytime soon, slowing inflation and some signs of weaker economic data have prompted investors to bet on declines early next year. But those bets have been shifting rapidly as traders weigh the Fed's official commentary with hints of cooling off elsewhere in the economy. For Cullinan, the amount of cash that pours into money market funds 'depends on the pace of the easing cycle.'"
In other news, the Bank of England recently posted a speech, "Going with the flow: how liquidity risks have evolved in the higher rate environment − remarks by Dave Ramsden," which was, "Given at the European Systemic Risk Board annual conference." It summarizes, "Dave Ramsden considers the question: What are the implications of the end of the low interest environment for liquidity risk and what are the macroprudential policy options? These remarks provide insights into how liquidity risks have evolved and consider how policymakers can best identify and respond to these risks."
Ramsden states, "I want to focus my remarks today is the conjunction of structural changes, liquidity and interest rate risk. Recent events have revealed that shocks can uncover vulnerabilities, exacerbating rapid or sharp moves in market interest rates -- independent of the impact of monetary policy -- leading to additional liquidity stress in the financial system, harming the functioning of core markets. As I will go on to describe, there is ongoing work at central banks to address the vulnerabilities that these events revealed. At the Bank of England, we are leading or supporting a range of work both nationally and internationally to strengthen resilience in non-bank market participants and infrastructure. In addition, we are developing new backstop facilities to tackle severe instances of dysfunction that threaten UK financial stability, including through lending to eligible Non-Bank Financial Institutions (NBFIs) in exceptional circumstances. In that sense we at the Bank of England are going with the flow of market conditions but it is very important that in doing so we don't in some sense determine the flow."
He says, "Financial institutions often manage their interest rate risk via interest rate derivatives or repos. The widespread use of derivatives and repos as part of financial institutions' interest rate risk hedging strategies mitigates idiosyncratic risks from changes in interest rates but creates liquidity risks to manage. In particular, it creates exposure to liquidity risk via margin or collateral calls when asset prices move. In normal market conditions, these risks are smaller and easier to manage. But in volatile conditions, the vulnerability can be exposed, often materialising through mismatches in liquidity supply and demand, causing sharp price adjustments and further negative feedback loops."
Ramsden tells us, "This was seen in UK liability-driven investment (LDI) funds in autumn 2022. Following a very sharp fall in gilt prices, levered LDI funds saw falling net asset values and faced liquidity pressures from large collateral and margin calls. To stem the fall in their asset values and meet these margin calls, some funds delevered by selling, or preparing to sell, their gilts. This put further downward pressure on gilt prices and began a self-reinforcing spiral posing a material financial stability risk. It was to avert this systemic risk crystalising that the Bank of England intervened, through the use of a temporary and targeted buy/sell operation to ensure LDI funds and their pension fund investors had time to place themselves on a firmer footing."
He continues, "The 'dash for cash' in March 2020 provided another clear example. A range of financial institutions, and in particular non-banks, sought to raise cash by selling bonds during that period. In that context of an already volatile and illiquid market, hedge funds with leveraged positions in US Treasury cash-futures basis trades closed out their positions, amplifying the moves. There has been a lot of focus on the renewed growth in hedge fund short positioning in US Treasury futures over the course of this year."
Ramsden adds, "Some NBFI business models incorporate inherent maturity and liquidity mismatches, which can arise when assets are less liquid or longer dated than liabilities. These mismatches expose weaknesses in liquidity risk management and could, for example, lead to firms requiring additional cash to meet liquidity shortfalls, forcing them to liquidate assets rapidly and putting further pressure on asset prices. Accordingly, the Bank of England is working to develop a lending tool for NBFIs to backstop market functioning in core sterling markets in the exceptional circumstances where there is a threat to UK financial stability."
Banking Risk & Regulation first wrote on the speech in, "BoE builds 'backstop facility' for nonbanks over liquidity risk concerns." It states, "The Bank of England's deputy governor for markets and banking has said nonbanks will be able to tap up a backstop facility amid concerns over elevated liquidity risk hitting the fast-growing sector. Dave Ramsden used a speech earlier this month to say that nonbank financial institutions would be able to access such lending under 'exceptional circumstances' in the future."
