Moody's Investors Service recently published a report entitled, "Money Market Funds - Cross Region: Continued asset growth drives stable outlook," which states, "Our global outlook for money market funds (MMFs) is stable, unchanged from last year. Interest rates will likely decline in 2024, and a negative outlook for the global banking sector will weigh on prime MMFs, which invest mainly in bank securities. However, geopolitical uncertainty will likely drive a further increase in MMFs' assets under management (AUM). Regulatory uncertainty has diminished in the US and EU, but the UK has proposed new liquidity rules for MMFs that diverge from the EU's. Tokenization is a promising technology for MMFs, but it will take time for its benefits to filter through."
It continues, "AUM and revenue will keep growing. In 2023, MMFs' assets reached record levels as rising yields reestablished them as a portfolio 'building block'. While interest rates will likely decline in 2024, we foresee further moderate AUM growth as regional military conflicts and electoral uncertainty make investors more risk-averse. This will drive continued growth in MMF sponsors' revenues.... In anticipation that interest rates will soon fall, MMFs in 2023 extended the weighted average maturity (WAM) of their portfolios to lock in higher yields for longer, reducing their liquidity. This trend will likely continue into 2024, although fund managers will remain cautious in case of potential market shocks."
Moody's tells us, "In July 2023, the US and EU authorities finalized planned reforms of their regulatory regimes for MMFs along lines that are broadly favorable to the industry. In December, the UK regulator proposed liquidity thresholds above those in force in the EU. If these are implemented in their current form, some EU-domiciled funds may need to increase their liquidity to maintain access to UK markets, reducing their yields."
The report tells us, "Assets under management grew strongly in 2023 as a rebound in yields reestablished MMFs as a standalone asset class with a role as an investment portfolio 'building block'. US Government MMFs and Prime MMFs achieved AUM growth of 24% and 46% respectively during the year. In Europe, the AUM of public debt constant net asset value (CNAV) and low volatility net asset value (LVNAV) funds grew by 32% and 7% respectively.... The operating environment for MMFs will become less supportive as central banks globally prepare to lower interest rates after around two years of monetary tightening.... Even so, we expect MMFs' AUM to keep growing, albeit at a more moderate pace. This is because military conflicts in Ukraine and the Middle East and elections with uncertain outcomes in many countries will encourage continued investment in 'safe haven' asset class."
It states, "In the US, MMF revenue grew at an annual compound rate of 106% in the two years to December 2023, driven by rising AUM and the elimination of fee waivers that were required to keep clients' overall returns positive during the low interest rate era.... We expect further moderate growth in revenue in 2024 as AUM continue to rise."
Moody's writes, "During 2023, MMFs began to extend the weighted average maturity (WAM) of their assets, reducing their liquidity, to lock in high yields on the basis that interest rates had reached their peak in this tightening cycle. While portfolio managers have some room for further WAM extension, we expect them to remain cautious amid uncertainty over when monetary loosening will begin. In addition, prime MMF managers in the US will need to comply with upcoming increased daily and weekly liquidity regulatory requirements. The increase in WAMs has reduced MMFs' holdings of liquid assets."
They say, "Inflows into the US Federal Reserve's reverse repurchase (RRP) facility were down 60% year on year at $1.02 trillion as of December 2023. They reached a record $2.55 trillion a year earlier, with MMFs accounting for 90% of the total. The decrease partly reflects a recovery in Treasury Bill (T-bill) rates, which were 3 basis points (bps) above the RRP rate at year end 2023. At year end 2022, the RRP rate exceeded the T-bill rate by 35 bps. The surge in RRP inflows at year end 2022 was also driven by a shortage of T-bills because congressional negotiations to lift the US sovereign debt ceiling had reached deadlock. The subsequent agreed increase in the debt ceiling boosted the supply of T-bills by 54% year-over-year. US government MMFs' exposure to US Treasury debt increased sharply in 2023."
Moody's also states, "Our outlook for global banks for 2024 is negative. The sector faces more difficult operating conditions in 2024 because of below-trend economic growth and higher interest rates, which will limit loan demand and squeeze loan quality. This is negative for the asset quality of prime MMFs, which mainly invest in short term bank debt. Prime MMFs will however benefit from an increase in the supply of bank debt as central banks reverse the quantitative easing programs they put in place during the low rate era. This will allow MMFs to diversify their portfolios, partly offsetting the impact of lower bank credit quality."
They add, "The credit quality of prime MMFs' investment portfolios deteriorated slightly in 2023, with Aaa-rated securities' share of onshore US prime funds declining by 10 percentage points. The credit profile of European prime funds slightly improved."
Moody's then writes, "While previous regulatory reforms in the US (2016) and Europe (2019) drove a structural transformation of the industry ..., we do not expect recent regulatory changes to alter the landscape. In July 2023, the US and EU authorities finalized reforms of their MMF regulatory regimes along lines that were broadly favorable to the industry. The European Commission confirmed that the low volatility net asset value (LVNAV) and public debt constant net asset value (CNAV) fund structures, which account for over 50% of the industry, would remain in their current form. An earlier proposal would have barred both fund types from using amortized cost accounting when calculating net asset values. This would have made it more difficult for LVNAV funds to maintain stable net asset values, significantly reducing their appeal to investors."
They tell us, "The US Securities and Exchange Commission's (SEC) final reform package omitted 'swing pricing', a mechanism that discourages preemptive fund redemptions by passing on their full price impact and transaction costs to investors that depart first. The MMF industry had opposed swing pricing on the grounds that it would be difficult and expensive to implement. The SEC's final package instead opted to impose a liquidity fee on redemptions under certain conditions, in addition to increased daily and weekly liquidity requirements, at 25% and 50% respectively."
Finally, they say, "In December 2023, the UK's Financial Conduct Authority (FCA) proposed minimum daily (15%) and weekly (50%) liquidity thresholds for MMFs above those that apply in the EU. If implemented in their current form, the new thresholds could force some EU-domiciled funds to increase their liquidity to retain access to the UK market, reducing their yields. Funds domiciled in France would be most affected as their liquidity falls short of the proposed UK threshold by the widest margin. The gap would be less significant for the Moody's Aaa-rated funds."
