Commentary continues to flood in on the recent spike in LIBOR, CP and CD rates, and on the massive asset exodus from Prime money market funds. J.P. Morgan Securities writes in its latest "Short-Term Fixed Income," "For another week, focus in the short-term fixed income markets was centered on Libor's ascent. Week over week, 1m, 3m and 6m Libor fixings rose 0.8bp, 3.3bp, 4.9bp respectively. Though the pace of increase slowed somewhat relative to prior weeks, it continued to make new multi-year highs, particularly in the longer tenors.... [T]he culprit remains very clearly the ongoing fallout from the approach of money market fund reform, influencing where banks have been funding in the wholesale unsecured markets. Based on fixed CP/CD transaction data from DTCC, average bank funding levels continued to trade above Libor fixings, dragging Libor higher along with it." We review this, as well as updates from OppenheimerFunds and Bank of America Merrill, below.
JPM's latest piece, by Alex Roever, Teresa Ho and John Iborg, explains, "To be sure, the heavy CP/CD maturity schedule over the next two months will likely continue to pressure Libor higher. Based on the most recent estimates from our banking partners, approximately $1,020bn of bank CP/CD paper was outstanding as of June month-end, with Japanese issuers in particular comprising the largest concentration.... If we assume the maturity schedule of those Japanese bank outstandings are similar to what’s in prime MMFs (which held roughly two-thirds of those outstandings), then there's at least $68bn of maturities that are going to be due over the course of this month. And of this amount, approximately $35-45bn are held in prime MMFs."
It adds, "That being said, there is some preliminary evidence that we have found a clearing level for some names, as reflected in the slower pace of increases in the Libor fixings. There are a few reasons that are contributing to this dynamic. First, as spreads have widened, participation from non 2a-7 prime institutional buyers has meaningfully increased, particularly in the longer tenors. These buyers include offshore funds, securities lenders, short-term bond funds, separately managed accounts, retail funds as well as large corporations that have excess cash on their balance sheets to deploy. Indeed, average weekly CP data from the Fed shows a 40% increase in 81+ days volumes week over week. While they are unlikely able to fill the void left behind by prime institutional funds, they have nonetheless helped to blunt some of the impact MMF reforms have imposed on some banks."
The weekly continues, "Second, and somewhat surprisingly, it appears banks have been willing to access shorter maturities in spite of regulatory incentives otherwise.... Third, it appears foreign banks have been willing to let their large deposit liabilities run off by drawing down on their reserve balances at the Fed.... Taken together, while pressures from MMF reform will likely continue to build as we draw closer to the deadline, we suspect the degree of impact on Libor will begin to subside, if it hasn't already. In other words, Libor will rise at a slower pace as funding levels begin to stabilize. Indeed, historically, we have found that Libor fixings tend to lag the funding markets, particularly during periods of volatility.... To this end, based on what we have seen bank in CP/CD data from DTCC, the intensity of funding pressures in 3m tenors may be close to peaking."
OppenheimerFunds' "The LIBOR Story Won't Go Away Anytime Soon," tells us, "Spikes to LIBOR tend to get noticed by market participants -- particularly, after the global financial crisis when LIBOR was seen as the figurative "canary in the coal mine." Recently LIBOR has spiked again, as our chief investment officer, Krishna Memani, noted in a recent blog. But the canary is quite healthy; it's the coal mine that has run out of coal. To explain in detail what is happening to LIBOR, we must study what we see as the root cause -- namely new Money Market Mutual Fund rules mandated by the industry's regulator, the Securities and Exchange Commission (SEC)."
Written by Adam Wilde and Ira Jersey, the piece continues, "The first and quite noticeable change has been a large shift of assets from prime to government MMFs. A large part of this shift so far has been from fund families converting their offerings from prime funds to government funds, while investors in some cases have also moved assets out of prime funds…. A second major change is that prime funds are positioning themselves for large outflows over the next several months."
It adds, "Estimates vary, but many predict hundreds of billions of dollars in outflows. Therefore, many prime funds have proactively reduced their weighted average maturity (WAM) and weighted average life -- both of which are now at all-time lows -- and are increasing fund liquidity. Flows have also been occurring as investor money is beginning to move out of funds that have chosen to remain institutional prime funds. More assets are anticipated to shift as we approach the October 14 date for the new rules to take effect."
Bank of American Merrill Lynch adds in a brief entitled, "70 days to Reform" in its "US Rates Weekly," "US dollar LIBOR settings have been shifting higher over recent weeks largely due to two factors (1) reluctance from prime money funds to offer unsecured funding at the 3-month tenor, which now extends beyond the mid-October reform implementation date, and (2) a potential pullback in willingness to lend post-Brexit. Of these two, we think that money fund reform is the larger contributing factor. The lack of prime fund supply has caused investors to raise their offering amounts to achieve funding beyond these tenors causing LIBOR rates to increase."
BofA's piece also discussed update survey results, saying, "With the ongoing focus on money fund reform, we recently expanded a survey of our short-duration clients to learn more about their expectations and hear how they were thinking of adjusting the cash balances as a result of reform.... In particular, we take away the following points: (1) respondents continue to expect a sizeable reallocation out of money funds ahead of the October implementation date (2) investments that shift out of prime funds are most likely to move into government money funds and bank deposits (3) most of the outflows from prime funds are not expected to return to this product even for the right yield (4) a large amount of prime fund outflow [will occur] in the month or two ahead of the reform date."
Finally, the BofAML survey results also show that: "Other alternative investments such as separately managed accounts, short-duration funds, and private placement funds were seen as much less likely alternatives;" "a roughly 30 basis point pickup would be required to keep investors in prime money funds;" "CP and CD issuers to adjust to money fund reform ... would be most likely to seek other financing sources or offer higher rates;" and, finally, "clients did not expect to move their holdings until less than one month ahead of the reform implementation date."
