Barclays: Rates Already Moving Higher
Barclays' Joseph Abate writes in his latest "US Money Markets," "As lift-off gets closer, all front-end interest rates have begun moving higher. In past tightening cycles, the 6m rate has typically risen faster than the 3m rate as there is more opportunity for the Fed to hike interest rates over a six-month window (at least in the early stages of a hiking cycle) As a result, the 3/6 basis has increased by an average of 13bp (and a median of 22bp) in the first three months of the past three tightening cycles. Since July, the basis has widened by 6bp.... Fed Chair Yellen's testimony this week strongly suggests the upcoming rate hike trajectory will be mild, so how much wider can the 3/6 basis move?" On "WAM shortening," he comments, "Our sense, however, is that the path of the 3/6 basis may depend more on the behavior of money fund investors than on the speed of the Fed's rate hikes. After years of "yield starvation" money fund managers have eagerly anticipated the Fed's lift-off this year by shortening up the maturities of their holdings. They shorten their maturities in order to capture as much of the increase in bank funding rates following a Fed rate hike as possible -- effectively timing the market. Indeed, since the start of the year, institutional prime funds have shortened the WAMs of their portfolio holdings to 29d from 45d in February.... Prime fund WAMs were even shorter ahead of the mid-September FOMC meeting as markets widely expected the Fed's lift-off would occur at that meeting. But when the Fed failed to raise rates in September, prime fund managers redeployed their cash into the short-term bank debt market -- although at only modestly longer maturities. In recent weeks, however, prime money fund portfolio WAMs have resumed shrinking as lift-off in December becomes more certain." Finally, Abate tells us, "There is a tight connection between the investment decisions of money fund managers and bank issuers as money funds hold a substantial portion of outstanding short-term unsecured bank debt in the form of CP, CDs, and wholesale time deposits. As fund managers are shortening maturities, two market effects are emerging. First, Treasury GC rates have been pinned to within a basis point of the Fed's RRP rate as cash that would ordinarily be invested in term unsecured bank paper has temporarily shifted into overnight Treasury repo. The repo "pile-up" has offset any of the cheapening expected from the substantial post-debt ceiling increase in bill issuance."
