Federated Investors sent out its latest "Insights" e-mail yesterday, which contained two links to money fund commentaries. The first, by Senior Portfolio Manager Susan Hill, is entitled, "Money Market Memo: Staring at the ceiling ... again," while the second, from MM CIO Deborah Cunningham, is entitled, "Month in Cash: Weather still freezing but economy thawing." Hill writes, "We hope the recent show of bipartisan cooperation that allowed Congress to agree on a budget and avoid another government shutdown doesn't prove to be fleeting. But with another debt-ceiling deadline rapidly approaching, and with politics being what they are -- particularly in this era of seemingly endless gamesmanship -- we feel it is appropriate to reiterate some thoughts on the issue in case Washington lawmakers are unable to resolve the matter as quickly as anticipated."

She explains, "To be clear, we continue to believe the United States will not default on its financial obligations -- ever. The debt ceiling that was suspended last October as part of the deal struck to end the government shutdown and fiscal showdown is set to be reinstated Feb. 7. However, the U.S. Treasury is expected to have approximately $30 billion in cash on hand at the time as well as about $200 billion of "extraordinary measures" at its disposal to continue to meet the financial obligations of the federal government at least through the month."

Hill tells us, "Treasury Secretary Jack Lew is being a little coy about the actual drop-dead date, but projections from most analysts suggest the Treasury won't actually run out of money if nothing is done until well into March. While we anticipate this latest debt ceiling go-round will be resolved without the heightened drama of last October, we would not be surprised if tensions began to build in the upcoming weeks. Contingency planning has become a necessary part of all of our lives in the aftermath of the global financial crisis, and as such we understand the need for shareholders to contemplate what the world might look like in the event of a technical default, and how money market funds could be affected".

She continues, "Of note: First, Securities and Exchange Commission Rule 2a-7, which governs money market funds, does not require that a fund dispose of a security that is in default. Rather, it permits the fund to continue to hold such a security, provided the board of directors of the fund has determined that disposal of the security would not be in the best interests of the fund. Rule 2a-7 indicates such determination may take into account, among other factors, market conditions that could affect the orderly disposition of the security. Given the expectation that any potential technical default on U.S. Treasury securities would be very short-lived, it is possible a fund's board could make the determination to continue to hold the security. It is also reasonable to assume that such a holding could be valued taking into consideration the expectation of being paid in full once the dust settles. Second, although all short-term securities might exhibit some degree of volatility during this uncertain but likely very short technical default time frame, we would expect the market reaction to remain substantially below the threshold at which significant downward pressure would be exerted on the net asset values (NAVs) of money market funds."

Hill adds, "Finally, there has been anecdotal evidence of some selling of Treasury securities with maturities around the time frame when the extraordinary measures are expected to run out. Although we remain steadfast in our belief that Congress will not allow a default, we are less confident in the actions of other investors in the front end of the market. As a result, we have avoided reinvestment of maturing securities in the March time frame and currently have no exposure to that area in any of our money market portfolios."

Finally, she says, "Federated's money market funds are absolutely committed to maintaining liquidity to meet the needs of their shareholders in the event that an increase in the debt ceiling is delayed. Rule 2a-7 already requires money market funds to maintain stringent minimum liquidity buffers for daily and weekly liquidity needs. As we have done heading into similar periods in the past, Federated would expect to continuously evaluate the potential liquidity needs of its money market funds and augment their existing liquidity position with greater daily or weekly positions, cash balances or alternate liquidity sources should it appear necessary if the conflict continues. In spite of -- if not because of -- the dysfunction in Washington, we want to reassure our shareholders that we have their best interests at heart with respect to safety and liquidity at all times."

Federated's Cunningham comments, "A frigid January kept the money markets on ice, despite some mixed signals from the U.S. and world economies. The Federal Reserve's decision to continue with tapering did not have a pronounced effect, as the commercial paper and cash markets held up well. Supply was pretty good without any hiccups, and the yield curve ended the month basically where it was at the end of December. We did see a flight to quality toward the end of the month on troubles in emerging-market countries as well as the Fed's decision to reduce monthly asset purchases, known as quantitative easing (QE), another $10 billion to $65 billion, split between mortgage-backed securities and Treasury securities."

She adds, "While this risk-off trade impacted the equity and bond market in the month's final week, from a money-market perspective, the Fed's decision to extend the experimental overnight reverse repo facility was more important and a positive. The Fed is testing the facility to help manage its an exit from extraordinary monetary accommodation of the past several years, and both our funds -- which have utilized the facility to the tune of a couple billion dollars daily -- and the broader market have benefitted. At the end of the December and into most of January, there would have been zero to potentially negative rates offered for some forms of repo had the Fed, through the facility, not improved supply and essentially set a floor on overnight rates. Supply and demand remains out of whack and continues to keep rates low, which is a key reason we welcome the Fed's extension of the program."

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