Wells Fargo Securities released a new "Money Market Monitor" commentary late yesterday, which discusses "Tier 2 Commercial Paper." Wells Strategist Garret Sloan writes, "We have been riding on the Tier-2 commercial paper bandwagon for quite some time, thus we approach this subject with perhaps a bit more enthusiasm than the truly dispassionate observer. Tier-2 commercial paper has ebbed and flowed in terms of its basis between tier-1 CP and total issuance outstanding, but the recent spread widening and the increase in total CP outstanding has pushed the bounds of what we have historically witnessed during any given period of relative calm. It seemed to us, therefore, important to identify the current market environment for tier-2 CP as particularly unique in terms of value proposition."
He explains, "One of the primary concerns for short-term investors, in our view, is overexposure to the financial sector, and within that definition we would argue that banks represent the majority share. As banks rely on a funding model that attempts to exploit the upward slope of the yield curve (i.e. borrow short and lend long) they are invariably the largest and most consistent issuers in short-term markets. Moreover, banks provide liquidity and credit support to other short-term securities that some might not consider direct bank exposure. This includes the variable-rate demand note (VRDN) and asset-backed commercial paper sectors. Using money market fund portfolio holdings as a proxy for short-term financial exposure, current data suggests that prime funds are 78 percent exposed to the financial sector."
Sloan notes "the importance of including non-financial asset classes in short-term investment strategies," and continues, "It has been suggested that the rise in tier-2 commercial paper has largely been the result of the Federal Reserve's definition of what constitutes a Tier-2 security. Under current definitions, if a CP issuer is placed on negative credit watch its outstanding commercial paper is placed in the lower rating category.... But the data may be somewhat misleading. The growth in the tier-2 market cannot be wholly attributed to banks on negative credit watch.
He points out that tier-2 CP market growth was already on the rise in Q1 2014, writing, "Moreover, we estimate that once bank-related CP programs are on watch, outstanding balances began to run off.... If we assume that the Jan-April 2014 growth rate in non-bank-related tier-2 CP was sustained until March 2015, the true level of non-bank tier-2 CP outstanding would climb to just over $104 billion.... It suggests that the recent growth in tier-2 CP is primarily attributable to growth in non-bank tier-2 CP and only partially attributable to bank rating activity."
In other news, yesterday Chicago Fed President Charles Evans discussed why he thinks interest rates should stay put until 2016 and provided an inside look at the Fed's "dot plot." He said, "In the latest projections made just last week, 15 of the 17 FOMC participants expected that it would be appropriate to raise the federal funds rate sometime this year.... The "median participant" expects the target fed funds rate to be about 1-3/4 percent by the end of 2016. In other words, according to the median path for the target fed funds rate as projected by FOMC participants, rate increases of about 50 basis points for this year and 100 basis points next year are to be expected. The FOMC meets eight times a year. So, the projected path is consistent with a 25 basis point increase at every other FOMC meeting."
He added, "I should note that this would be a considerably slower, more gradual pace of rate increases than those implemented in 2004 through 2006 -- the last time the Fed normalized policy following an extended period of very low interest rates.... [M]arket expectations puts the target rate at the end of 2016 at about 1 percent -- 75 basis points below the median FOMC forecast."
Evans continues, "What is my personal view of the appropriate path for Fed policy? I think economic conditions are likely to evolve in a way such that it will be appropriate to hold off on raising short-term rates until 2016. Economic activity appears to be on a solid, sustainable growth path. However, inflation is low and is expected to remain low for some time -- and I have serious concerns that inflation will run even lower than I expect.... In summary, I think we should be cautious in raising interest rates."
Finally, PIMCO released its "9th Annual Defined Contribution Consulting Support and Trends Survey", which polled 58 consulting firms that represent $3.2 trillion in defined contribution/401(k) plan assets on trends in that marketplace. There were a couple of data points related to money market funds. One said that as a single, standalone strategy for capital preservation, 89% of consultants favored stable value funds, while 73% favored money market funds, over low-duration and short-term options. Also, 75% of consultants said it was important for fiduciaries to review their use of money funds in light of the SEC’s MMF reforms, while 23% said it was very important. Further, 75% of consultants said they were likely or very likely to recommend a switch from MMFs to stable value funds.
