Tuesday, the Federal Reserve's Open Market Committee lowered its federal funds target rate by 50 basis points to 1.0%. It also cut its little used discount rate by 1/2 percent to 1.25%. (See the full Fed statement here.) This move marked the Fed's ninth rate cut since September 2007, when the Fed funds target stood at 5.25% (and our Crane 100 Money Fund Index stood at 5.05%) . Money market rates should move lower in coming weeks, though most money funds will not encounter any partial fee waiver issues due to the current much-higher-than-Fed-funds levels of prime money funds and commercial paper. (See yesterday' News "Funds Brace for Ultra-Low Rates; Treasury Funds Avoid Zero Yield".)
The Fed's statement says, "The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures. Business equipment spending and industrial production have weakened in recent months, and slowing economic activity in many foreign economies is damping the prospects for U.S. exports. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate in coming quarters to levels consistent with price stability."
It continues, "Recent policy actions, including today's rate reduction, coordinated interest rate cuts by central banks, extraordinary liquidity measures, and official steps to strengthen financial systems, should help over time to improve credit conditions and promote a return to moderate economic growth. Nevertheless, downside risks to growth remain. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability."
We expect our Crane 100 Money Fund Index, the average 7-day annualized yield of the 100 largest taxable money funds, to move lower in coming weeks. The Crane 100 is currently 2.19%. It theoretically should move to 1.69% over the next 39 days (the average maturity of money funds), though abnormally high LIBOR, commercial paper and ABCP rates, and a recent rebound in Treasury yields, should delay or perhaps ignore the impact of this latest cut. Rates should come down slowly too as money funds moving back into higher-yielding options like CP.
Crane Data believes that the Federal Reserve will not cut rates below 1.0%, which we think is effectively the "floor" on the Fed funds target rate. The importance of this barrier was established from June 2003 through June 2004, the last time Fed funds hit 1.0%. Any cuts below this would force many of the highest expense money market funds to waive fees in order to avoid zero or negative yields. But the majority of assets wouldn't be impacted until rates sank below 0.5%. (The average expense ratio of money market mutual funds is currently 0.47%.) We have already seen sporadic fee waivers in selected Treasury funds over the last month, but we don't expect waiving to avoid negative yields to be a major issue for funds overall.
