Bank of America Merrill Lynch published a "US Rates Watch" update entitled, "Money market client survey: MMF reform shifts to be long lasting" earlier this week. Written by Mark Cabana, the piece tells us, "It has been nearly 5 months since 2a-7 money market mutual fund reform took effect, which saw over $1tn move out of prime funds and a similar amount into government funds. To gain some perspective on the outlook for money markets, we recently conducted a survey of our corporate clients. We wanted to better understand the conditions under which clients would consider shifting funds back into prime, alternatives they were considering to enhance yield, and how international tax reform might impact money markets."

It explains, "This survey is a compliment to the surveys we conducted prior to 2a-7 reform last year. Our survey was conducted from February 15–24 and was sent to corporate accounts that are active in money markets. We received 40 responses and more detail on our respondents can be found in the appendix." (The Appendix adds that "all clients were corporations that invest in money markets (not investment managers).)

Bank of America's update explains, "The key takeaways from our survey include: Shifts as a result of money market mutual fund will likely be long lasting with the vast majority of survey respondents suggesting they will not be adjusting their prime fund allocations in the near term; The required yield to move back into prime funds was most frequently cited at 60bps, approximately 30bps higher than current yield levels. Survey respondents expect that roughly $275bn of the over $1trn that left prime would return to the asset class in the next 18-24 months; Liquidity and safety appear to be prioritized over yield enhancement; and, Repatriation is expected to result in reduced offshore cash holdings but views on the broader money market impact were more mixed."

BofA's Cabana writes, "In-line with the over $1tn shift out of prime funds since late 2015, our survey respondents also meaningfully reduced their prime MMF holdings. The vast majority our respondents reported they reallocated over 80% of their cash holdings out of prime and into government MMF as a result of 2a-7 reform. This is similar to the 85% decline of institutional prime MMF holdings across the industry. Outside of the prime to gov't shift, survey respondents reported only modest increases in bank deposits, separately managed accounts, or Treasury/agency direct holdings."

He continues, "Most of the movement out of prime funds appears to be structural, according to our survey respondents. The vast majority of survey respondents suggested that they would not be adjusting their prime fund allocations over the next year. Even if offered more attractive yields, 50% of respondents suggested they would not consider moving back into prime funds while 42% of respondents might consider moving back for the "right yield" in the next year."

Merrill's survey update says, "When asked about the "right yield" to move back into prime funds, nearly 50% of respondents suggested that the 7-day yield differential between prime and government MMF would need to be greater than 60 bps. This is a notable increase from our money fund survey published this past June in which 55% of respondents suggested they would require a yield pickup of between 20-40 bps. It is also double the current 7-day net yield differential of roughly 30bps."

The piece states, "Respondents also indicated that some of the required spread pickup may be a function of Federal Reserve rate increases. Client weighted average responses suggested their required yield would increase 10bps for every 25bp Fed rate hike. Such a widening yield differential would be inconsistent with recent history where the prime to government spread widened only modestly as the Fed raised rates 425 bps during the 2004-2006 hiking cycle. It also suggests a very high threshold amongst clients for inflows back into prime funds."

It continues, "Client expectations for the total amount that would return to prime funds were more optimistic than for their own portfolios. A weighted average of survey respondents suggested that roughly $175bn could move into prime funds in the next 6M and that a total of roughly $275bn could move back over the next 18-24M. However, there were a relatively wide range of responses to this question and the modal response suggested that less than $100bn would move back into prime over both time horizons."

Cabana also tells us, "Survey respondents also indicated that they were not aggressively looking to enhance yield on their cash holdings. When asked about alternatives they were considering for increasing yield on their cash holdings, most suggested that they were looking into government funds, bank deposits, or direct investments in CP & CDs. Respondents indicated that they were generally not considering or only moderately considering other higher yielding alternatives such as enhanced cash funds, short duration funds, or private placement funds. This suggests that clients are likely willing to prioritize liquidity and safety on their cash holdings in relation to higher yields in a post 2a-7 reform environment."

Finally, he adds, "Clients were also asked about the impact of any international tax reform changes that could result in repatriation of offshore dollars. While there are still numerous outstanding questions associated with tax reform, respondents generally expect that any opportunity to bring cash back onshore would result in offshore money fund balances being drawn down. Respondents had more mixed expectations of the broader repatriation impact on money markets; a similar number of responses suggested that repatriation flows would increase funding strains via the cross currency basis market as those that expected no material impact to money markets."

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