Bloomberg writes "Money Markets' $1 Trillion Exodus Is Having Far-Reaching Effects," which discusses some of the impacts of last year's massive Prime to Government shift. It says, "Regulators' effort to stamp out risk in the $2.6 trillion U.S. money-fund industry is creating unintended ripple effects across financial markets, with far-reaching consequences for companies and investors." We review this article, as well as recent posts by Federated and Citi on the Fed and Repo markets, respectively, below.
The piece explains, "Far less cash than anticipated has returned to the higher-yielding slice of the money-fund world, after the overhaul that took effect in October led to a $1 trillion exodus from what are known as prime funds. They've been the principal buyers of the commercial paper that companies and both foreign and domestic banks have sold for decades to obtain short-term U.S. dollar- denominated financing."
Bloomberg tells us, "By squelching demand from prime funds, commercial-paper rates relative to other money-market securities have risen, and are now at the highest levels since the financial crisis, causing borrowers to seek new sources of funding like the short-term securities lending market. Investors are also feeling the pinch -- most money funds are stuck with Treasury bills offering paltry rates. What's more, the massive shift toward funds that can only buy the safest U.S. debt has created the potential for a bottleneck if Congress is unable to resolve long-simmering disputes related to the nation's debt ceiling."
They add, "The changes included institutional prime funds abandoning the long-held tradition of having asset values locked at $1-per-share. Holdings in prime funds fell to a record low $373 billion after the reforms went into effect in October, ICI data show. Since the implementation deadline, total prime fund assets have only rebounded by about $25 billion. Most of the prime outflows ended up in government-only funds, which were exempt from the changes."
The article also says, "Among foreign institutions, Japanese banks' exposure to prime funds fell to $44.9 billion in February from $174.6 billion in October 2014, while French banks' exposure dropped to $62.1 billion from $165.2 billion, Securities & Exchange Commission data show. Prime funds slashed U.S. bank holdings to $53.9 billion from $233.2 billion. As an alternative, non-U.S. banks have gained about $140 billion of funding via repurchase agreements with government money funds, according to the BIS. Ninety-day commercial-paper rates are about 1 percent, compared with 0.9 percent for similar-maturity repos."
"Wherever you have those big dollars moving around, they themselves are a risk," said Peter Crane, president of Westborough, Massachusetts-based Crane Data LLC. "You put a bunch of 800-pound gorillas in a room, and if all of a sudden everyone wants to get out, they are going to break down a wall."
Finally, Bloomberg writes, "One silver lining for prime funds is the widening gap between yields on the two types of funds, which could eventually lure back more cash. But even if some money returns, it will only be a fraction of what was lost, because some investors, including sweep accounts, are required to place their cash in money funds with a constant net asset value. Other fund companies, such as Fidelity Investments, which converted their institutional prime money markets to government-only, are unlikely to revert.
In other news, Federated Investors' Deborah Cunningham writes "Month in Cash: Inflection point in Fed policy?" She comments, "If you could predict swings in the markets, you would, of course, be very rich. But inflection points only get determined after the fact. For cash managers, the crucial question these days is whether or not the Federal Reserve has shifted monetary policy. Does the Fed still view its rate hikes as normalization -- raising rates from extraordinary accommodation -- or as tightening, i.e., adjusting rates to check inflation?"
Cunningham continues, "We are taking the position that March was the tipping point for policymakers (save Minneapolis Fed's Neel Kashkari), when their mindset changed from keeping the economy on life support to shepherding it to prosperity. This is not just because the Federal Open Market Committee (FOMC) voted to raise rates by 25 basis points to a range of 0.75-1% at its mid-March meeting, but because its summary of economic projections and Chair Janet Yellen's press conference suggested two more hikes could come in 2017. And in the weeks since the FOMC meeting, some Fed officials are leaving the door open for even more moves if economic conditions don't surprise to the negative. That's a far cry from the last two years, when the Fed led the markets to expect multiple hikes, only to offer one each year."
She also says, "However things turn out, money fund managers should have a clear path to reacting to them. Supply of issuance should not be a problem. The U.S. reached its legal borrowing limit in March, although the U.S. Treasury says it could employ extraordinary measures into autumn if needed to avoid an actual debt-ceiling crisis. The Treasury has been good about communicating to the market, and the Fed's management of the federal funds range (with reverse repo and interest on excess reserves as bounds) has been working well, with the benchmark rate itself in the mid-80s. The London interbank offered rate (Libor) continued to rise over March."
Finally, Citi's Steve Kang writes "CCIT: The brave new world for tri-party repo?" He explains, "In January the DTCC announced it would expand its GCF repo clearing service to the tri-party repo market under a Centrally Cleared Institutional Tri-party (CCIT) Service, which is currently pending regulatory approval. Last week a Bloomberg report on CCIT appeared to trigger a widening move in swap spreads and OIS/Tsy spreads, likely in anticipation of structural richening of repo due to the introduction of CCIT. However, we argue that the effect on the repo market from the existing proposal is likely to be minimal due to the limited scope of participants and the limited balance sheet benefits for dealers. While there is potential for a larger impact on the repo market if the scope of the clearing platform broadens, we do not expect it to happen this year."
Kang tells us, "Eligible cash lenders will be required to obtain Tier-2 CCIT membership and open a tri-party account with CCIT. It is important to note that new CCIT membership is only for non-dealer cash lenders and NOT for non-dealer cash borrowers. The current proposal also excludes RIC lenders. This, in particular, excludes 2a7 money market funds, mutual funds, hedge funds, REITs and certain sec lenders. The largest non-RIC cash lenders include corporate accounts and separately managed accounts."
He adds, "The market size of tri-party -- excluding Fed and GCF -- with Fedwire eligible collateral (USTs and Agency MBS) is around $1.2tn. Out of this, 2a7 lends (RIC) around half of those transactions (around $600bn). This gives us an upper bound of around $600bn for the tri-party that could be done in the CCIT platform. However, there are other RICs that are excluded from CCIT, such as asset managers and certain securities lending agents, who are likely to be a large part of this market. We therefore expect a much smaller subset of eligible tri-party repo for CCIT."
