JP Morgan Securities recently released its "Short-Term Fixed Income 2016 Outlook," which discusses expectations for money market supply in 2016. They write, "For another year, the short-term markets will have to adapt to the presence of fewer investment opportunities. However, unlike prior years the contraction in supply will not be driven by issuers and their need to de-lever their balance sheets. Instead, it will be driven by investors and their demand for these products, which under MMF reform is expected to decrease materially. Overall, we think total money market supply (excluding Fed ON RRP) will remain flat year-over-year, decreasing by a moderate $48bn. However, credit supply (total ex-Treasuries) could decrease by 3.6% or $170bn." (Note: JPMorgan Securities' Teresa Ho will present the segment on "Instruments of the Money Market" at our upcoming Money Fund University, Jan. 21-22, 2016 in Boston.)
The piece contains a table that shows that "Total Money Market Supply (ex-Fed) at year-end 2015 includes: Dealer Repo ($1.625 trillion), Treasuries ($3.230 trillion), Agencies ($972 billion), Financials ($1.290 trillion, which includes $785B in Yankee CDs and $470B in CP), ABCP ($220 billion), Non-Financial CP ($286 billion), and Bonds <1Yr ($352 billion). For year-end 2016, they estimate these totals to be: Dealer Repo ($1.610 trillion), Treasuries ($3.803 trillion), Agencies ($906 billion), Financials ($1.105 trillion, which includes $700B in Yankee CDs and $355B in CP), ABCP ($200 billion), Non-Financial CP ($315 billion), and Bonds <1Yr ($376 billion). Total supply (ex-Fed) is expected to be $8.315 trillion at the end of 2016 (vs. $7.975 at the end of 2015), the report tells us.
JPM's Outlook takes a closer look at the various sectors, starting with Repo. They write, "Much like this past year, repo will remain a subject of discussion in 2016. The focus, however, will not necessarily be on the reduced level of tri-party repo outstandings. In fact, outstandings in this market have largely stabilized around $1.6tn and we would expect these balances to hold up next year.... As for tri-party repo, MMF reform is expected to significantly increase the demand for Treasury repo.... [I]t's likely that tri-party outstandings next year will remain around its current level of $1.6tn."
JPM continues, "Following the debt ceiling suspension to March 2017 earlier this year, Treasury outstandings are poised to increase fairly substantially in 2016. Much of the growth will be driven by an increase in bill supply, to the tune of $173bn, as Treasury looks to address the lack of liquidity in the bills market.... Treasury's desire to extend the WAM of its debt portfolio has pushed Treasury bill outstandings to a record low of 10% of its total debt.... Treasury has stated that it intends to increase the net supply of bills significantly in 2016.... [T]he additional bill supply is a welcome reprieve following months of reduced net bill issuances. On margin, this should also boost bill yields higher."
On Agencies, they explain, "In 2016, much of the factors that drove discount note outstandings over the course of this past year will likely apply again next year. Across the GSEs, our Agency strategists are projecting discount note outstandings to increase by $5bn year-over-year, with FHLB contributing $25bn of the increase while FNMA and FHLMC each see a decline of $10bn. For FHLB, its growth in the discount note market will continue to be driven by FHLB advances, which we expect will continue to rise next year.... Taken together, FHLB is on pace to represent more than 70% of the discount note market by the end of next year."
The piece tells us, "We estimate outstandings of financial CP/CDs will decrease by $150bn or 12% year-over-year. Central to our estimates is how MMF reform unfolds next year. The prospect of a mass cash exodus out of prime MMFs creates material challenges for bank issuers to continue to fund in the money markets. As of October month-end, roughly 45% of prime assets (or $631bn) is invested in bank CP/CDs. As a percentage of the market, MMFs fund about half of the total US CP/CD market. In 2016, our expectation is that an additional $450-$500bn (not including sponsor conversions) will exit prime MMFs and make their way to government MMFs as shareholders react to MMF reforms. All else equal, this would imply MMFs could withdraw about $220bn (45% x $500bn) from the bank CP/CD market. That said, monetary policy complicates our outlook.... Government MMFs are constrained in their ability to absorb a significant amount of cash from prime MMFs without an increase to the Fed's ON RRP facility. In such a scenario, the bid for government money market assets such as bills, discount notes and repo could be so intense that even as the Fed normalizes interest rates, yields on government assets could remain suppressed."
It continues, "Why does this matter? For some MMF shareholders, there is a level, and we don't know what that level is, that they might feel compelled to stay in prime MMFs provided they feel they are being sufficiently compensated for the risk of investing in a prime MMF over a government MMF.... On net, we are inclined to think bank CP/CD balances will move lower by $150bn next year, driven largely by the sizable outflows that are expected to take place to prime MMFs but offset by some of the other moving parts related to rates and other liquidity alternatives."
JPM also comments, "Similar to bank CP/CDs, ABCP will be subject to the same market forces next year. MMF reform and the potential associated outflows will see overall reduced demand from prime MMFs. The good news is that ABCP issuance tends to be short-dated in nature (roughly 70% of its issuance is in the 1-9 bucket), allowing prime MMFs to use some of these assets for liquidity purposes, softening some of the decline related to MMF reform. As a result, we expect balances to be relatively stable, perhaps falling to $200bn by the end of next year."
They add, "Similar to prior years, we expect balances for non-financial CP to continue to grow, with outstandings likely to surpass the $300bn mark in 2016. Market forces from both the supply and demand side of the market will contribute to its growth, boosting balances to the highest level over the past 15 years.... For prime MMFs that have historically relied on these asset classes for liquidity, going forward they may have to resort to alternatives to fulfill their liquidity requirements. Here is where non-financial CP would be an ideal substitute as most corporates issue CP on a very short-term basis. Additionally, the removal of credit ratings in Rule 2a-7 will likely encourage non-rated prime MMFs and "2a-7 like" investors to invest in more Tier-2 corporate paper, thus contributing to the overall increased demand for the non-financial CP sector."
Finally, regarding the Fed's ON RRP, JPM strategists write, "Following liftoff, the level of the ON RRP rate will be a function of the demand by approved counterparties relative to the available supply of both Fed ON and Term RRP. We expect the Fed to raise the ON RRP target to 25bp from its current offering rate of 5bp. The prospect of this 20bp bump will attract heavy interest from the approved counterparties. Although daily demand for ON RRP this year has averaged just over $100bn per day, we anticipate demand at the new higher rate will be several times this.... [W]e estimate investor demand for ON RRP could reach about $662bn in the weeks after liftoff."
