Hollenhorst on Fidelity Changes
In his latest "Short End Notes," Citi Research's Andrew Hollenhorst writes, "Prime Fund Outflows May Widen LIBOR-GC." Hollenhorst explains, "Last week Fidelity announced that it will be converting three prime money funds, which hold credit product like certificates of deposit (CDs) and commercial paper (CP), into government funds which hold only government related securities.... We expect the decision to lead to significant flows (approx. $100 billion) into government securities and out of CDs, CP and non-government repo.... Fidelity's announcement was surprising to market participants for at least three reasons. First, the final compliance date for institutional prime money funds to transition to floating NAV is not until October 2016, and many short-term investors had expected cash to only start shifting much later this year or early in 2016.... Second, most had expected cash to slowly shift out of prime funds and into government funds as over time some corporates and individuals would decide they were uncomfortable keeping cash in a product subject to floating NAV and/or gates and fees.... Asset manager led shifts are likely to result in more cash moving out of prime and into government since cash will move if money fund investors take no action, rather than investors needing to proactively reallocate. Finally, and probably most surprisingly, the $112 billion Fidelity Cash Reserves Fund is characterized as retail rather than institutional. Most short-term investors had expected outflows from institutional prime money funds since regulators view retail cash invested in prime funds as "sticky" and are not requiring retail funds to float their NAVs. Rather than floating NAV, it seems the concern is over the redemption gates and liquidity fees that money funds will now be able to impose if liquid assets in the fund decline below a threshold." He adds, "Based on average government money fund holdings we would expect about $10 billion of Treasury demand, $65 billion of new demand for short-end agency paper, and $30 billion of repo demand. However, sourcing $65 billion in agency paper may be difficult in a year where we forecast close to zero net issuance and the funds may opt to place more cash in repo. Both of the larger funds are Fed reverse repo (RRP) counterparties allowing them to access up to $30 billion each in RRP and we expect to see usage of the facility increase once cash starts to shift. The increased demand for government securities may drive repo rates 1-2bp lower while the decreased demand for bank paper could lead to marginally higher bank funding costs. Hence we view the announcement as supportive of our view that the LIBOR-GC spread will widen."
