State Street Global Advisors hosted a webinar recently called, "The New World of Cash - Rate Hike Scenarios, which was moderated by SSgA's Head of the US Cash Business Yeng Butler, and featured Portfolio Strategist Will Goldthwait and Head of Global Cash Management Matt Steinaway. On interest rate hikes, Goldthwait said, "I'm taking a more hawkish view on Fed policy in the coming year. I believe that the Fed is going to raise interest rates or raise their target range, as Yeng described, at their June meeting. One thing that I'll be on the lookout for is when they drop the "patient" phrase in their FOMC minutes. I would expect at the March meeting we're going to see that "patient" word dropped, and that will lead to the June meeting for a Fed rate hike."
Steinaway discusses what cash investors should be looking out for this year. "There have been significant shifts resulting from regulatory activities, both around Dodd-Frank, Basel III and 2a-7 Money Fund Reform, but there have been substantial shifts in supply mechanisms and demand mechanisms in the liquidity markets. So we have seen within the supply mechanism in the market, we have seen a decreased issuance from banks, financial institutions, three months and in, and that does make it more challenging to manage a portfolio in a rising rate environment where you're trying to keep your weighted average maturities relatively short."
Steinaway continues, "The second issue, the shifting asset mix in the money fund universe, speaks directly to the 2a-7 money fund reform. We have seen the potential for, and in fact in some cases an announcement around the movement from prime money funds that do buy short-term paper, bank paper and repo and Treasury bills, into funds that only purchase Treasury bills. So, again, that is additional pressure on the front end, particularly in a high-quality Treasury space, where a lot of investors in a rising rate environment would normally seek short-duration, high-quality assets. It is our view that that shift will make those assets much more expensive, much more scarce. So we do think this cycle, this rising rate cycle, will be more challenging for cash managers as they enter the cycle because of the regulatory challenges in front of us."
In conclusion, Butler says, "I think we can conclude that the global market environment for cash has never been more challenging. The investment offerings that will be available to cash investors will be changing more in the next few years than they have in the past 20."
In other news, Fidelity Investments, which recently announced that it will convert 3 Prime retail MMFs to Government funds including the $112 billion Fidelity Cash Reserves (see our Feb 2 "News"), released a paper entitled, "Government Money Market Mutual Funds Remain an Attractive Option for Investors." Fidelity discusses supply, particularly in the government sector.
They write, "In the wake of MMF reforms, Fidelity expects the supply of government securities will continue to be sufficient to accommodate the potential growth in demand from investors choosing to move from floating-NAV prime funds to stable-NAV Treasury and government funds. The liquidity levels of these funds typically far exceed the minimum levels required by Rule 2a-7. Even those fund holdings that do not technically qualify as either daily liquid assets or weekly liquid assets generally exhibit favorable liquidity characteristics versus nongovernment securities. Government MMFs have offered competitive yields when compared with prime MMFs. For much of the period from January 1995 to today, the yield difference -- or spread -- between prime and government MMFs averaged about 0.06%, the exception being the two-year period spanning the financial crisis."
Finally, the Federal Reserve's latest semiannual Monetary Policy Report says prime money market funds could be vulnerable to investor runs. The report was covered by The Wall Street Journal in, "Fed Flags Concerns About Mutual Funds, Exchange-Traded Funds." There are a few passages related to money market funds, including one related to the vulnerability of prime money market funds and a recap of the Overnight RRP operations.
Under the section, "Developments Related to Financial Stability," the Fed report says, "Reliance on wholesale short-term funding by nonbank financial institutions has declined significantly in recent years and is low by historical standards. However, prime money market funds with a fixed net asset value remain vulnerable to investor runs if there is a fall in the market value of their assets. Furthermore, the growth of bond mutual funds and exchange-traded funds (ETFs) in recent years means that these funds now hold a much higher fraction of the available stock of relatively less liquid assets -- such as high yield corporate debt, bank loans, and international debt -- than they did before the financial crisis. As mutual funds and ETFs may appear to offer greater liquidity than the markets in which they transact, their growth heightens the potential for a forced sale in the underlying markets if some event were to trigger large volumes of redemptions."
Finally, under the subhead, "Additional Testing of Monetary Policy Tools," it states, "During policy normalization, the Federal Reserve also intends to use an overnight reverse repurchase agreement (ON RRP) facility and other supplementary tools -- including term reverse repurchase agreements (term RRPs) and term deposits offered through the Term Deposit Facility (TDF) -- as needed to help control the federal funds rate <b:>`_."
