Fidelity Investments published "Money Markets: Preparing for the New Reality," which reflects on a transformative year for money markets in 2014 and looks ahead to 2015. The Fidelity commentary, authored by Nancy Prior, Michael Morin, and Kerry Pope, says "What a difference a year makes. The money market landscape changed significantly in 2014, with implications for monetary policy, supply, and the regulatory environment. Specifically, U.S. economic growth evolved from a weather-induced first quarter contraction to the strongest consecutive six-month stretch of economic growth since 2003. Final rules for money market mutual fund reform were approved in July 2014, and the Federal Reserve (Fed) concluded its quantitative easing (QE) initiatives."
It continues, "The Fed reverse repo (RRP) facility and term repo programs played dual roles in the money market this year. In addition to their potential use in a policy shift, the programs' rules were modified in November to ensure the facility provided a solid floor under overnight market rates in anticipation of year-end. Scarce supply has been a long-term trend in the money market, presenting particular challenges as the third quarter came to a close, and the RRP facility changes should help provide additional supply."
Further, Fidelity writes, "The regulatory environment for money market mutual funds was also transformed during the year. After four years of deliberation, the Securities and Exchange Commission (SEC) approved new rules that will further regulate the money market mutual fund industry. The rules are scheduled to be fully implemented by October 2016 and are intended to increase the transparency of money market mutual funds, as well as give their investors additional protection during periods of extraordinary market stress."
So what's the outlook for 2015 -- higher rates or global headwinds? Fidelity writes, "The most recent economic data showed continued strength in the economy and progress in the labor markets, keeping investors' expectations focused on a potential rate hike in either the summer or fall of 2015. Global headwinds, however, especially weak inflationary pressures and slowing growth in Asia and Europe, could postpone the timing of any U.S. monetary tightening."
Fidelity also recapped the details of the operations within the Fed's $300 billion term Fed RRP facility. They highlight the three main points: "(1) transactions will mature no later than January 5, 2015; (2) operations will be conducted in a Dutch auction format, a bidding process in which the lowest rates submitted are accepted until the cap is reached. At that point, all those bidding at the highest yield accepted at the auction—known as the "stop-out rate," or "stop" -- or below are awarded their respective bids at the stop-out rate; and (3) operations will be subject to a maximum bid rate of 10 basis points. This new term facility will serve to further the goals of the overnight Fed RRP, but only over year-end."
The piece continues, "Other noteworthy aspects of the FOMC minutes revealed that the Fed is considering the introduction of segregated cash accounts (SCAs). This potentially nontraditional tool could assist the Fed in normalizing policy by possibly helping to reinforce a floor under short-term rates. SCAs would allow banks to pledge funds held in a segregated account at the Fed as collateral. Simply stated, a bank would earn the IOER (interest on excess reserves) rate on the balances in the account and would in turn pay the depositors a negotiated rate. The bank's depositor would have a claim to those reserves in the event the bank became insolvent."
Finally, they discussed their strategy going forward. "Fidelity's prime institutional money market mutual funds remained focused on year-end positioning. Supply in the markets remains very thin and we expect supply to continue to shrink as we approach the end of 2014. With that in mind, the funds have been seeking high-quality investments that mature in 2015, and participating in longer-dated floating-rate transactions. As we head into the final weeks of 2014, we anticipate supply to become even more limited and that the funds will increase their utilization of both the overnight and term Fed RRP facilities."
Vanguard writes in its "2015 Global Economic and Investment Outlook", "Central bank policies should diverge over the next several years. In line with Vanguard's outlook for 2014, we believe the Federal Reserve will keep short-term rates near 0% through mid-2015. We stress, however, that the Fed's rate rise will likely be more gradual (either moving in smaller increments or pausing) and will end lower than some predict, after accounting for the structural nature of the factors restraining growth. The European Central Bank (ECB) and the Bank of Japan may be hard-pressed to raise rates this decade. Indeed, across most major economies, real (inflation-adjusted) short-term interest rates are likely to remain negative through at least 2017.... The Fed's rate liftoff may induce some market volatility, but long-term investors should prefer that to no liftoff at all."
Finally, Dreyfus Senior Portfolio Manager Patricia Larkin writes in her latest "Taxable Money Market Commentary," "While 2015 may well be the year the Fed finally raises short-term rates, it is clearly not a foregone conclusion. The pace of domestic growth as well as financial and monetary conditions around the world will shape the Fed's ability and willingness to move toward higher rates. The money market fund industry will also be tested by looming regulatory changes both to the funds themselves as well as to many issuing entities. During this period, we intend to follow our long-held conservative credit policy while seeking to maintain appropriate levels of liquidity."
