J.P. Morgan Securities writes in a recent "Short-Term Fixed Income: Mid-Year Outlook," "Though 3m Libor-OIS has retraced to more normalized levels since hitting a high in early April, pressures remain that will likely continue to favor elevated Libor-OIS levels in the near term. First, seasonal funding needs on the part of Treasury will likely prompt net bill issuance to increase again later this year. Currently, our Treasury strategists estimate net bill outstandings will grow by [about] $290bn in 2H18." We excerpt from parts of their latest update below. (Note: Our apologies for the lack of new commentary today. We were too busy at our Money Fund Symposium, which wraps up today in Pittsburgh, to update our News! Thanks to those who attended our show, and watch for coverage from our big show in coming days.)
The Outlook tells us, "Though this is slightly smaller than the $330bn increase we saw earlier this year, we note there is also less capacity on the part of money market investors to absorb this supply as evidenced by the lack of use of the RRP facility. To this end, as Treasury bills increasingly comprise a larger part of money market supply ([about] 20% currently), competition with other money market alternatives such as repo, agency discount notes, and CP/CD will naturally bias those rates higher."
It explains, "Against this backdrop, money market participants will likely continue to maintain a short duration profile given expectations of two more Fed hikes this year in September and December. Looking at prime MMFs as a proxy, WAMs and WALs across both onshore and offshore MMFs on average have fluctuated around 25-30 days and 55-60 days respectively during the past six rate hikes, four of which have occurred on a quarterly basis.... The desire of investors to purchase short-dated paper will likely continue to exert pressure in the short end of CP/CD markets, particularly for those issuers who are limited in their ability to access longer parts of the curve (i.e., 6m and longer)."
J.P. Morgan's piece says, "Taking our bill supply forecast into consideration as well as incorporating MMFs' behavior on the back of Fed expectations into our fair value model, this would seem to suggest that Libor-OIS has room to modestly widen between now and year-end.... On a macro level, this is consistent with our derivative strategists' expectations for FRA/OIS.... Tacking on our views on the Fed and EFFR, we look for 3mL to end the year at 2.90%."
It explains, "What are the risks to this view? Tax repatriation is a wildcard. For now, corporations are building liquidity in their cash portfolios by investing in money market instruments as a parking place for cash. However, at some point, buybacks, dividends, and other corporate purposes may prompt corporates to draw down this cash."
JPM adds, "While we believe that this will likely have a limited impact on the front end, as cash inflows from excess cash from operations and maturities of longer-term securities could also be used towards shareholder activities, to the degree the corporations decide to accelerate their returns to shareholders, this increases the risk of a greater drawdown, and MMFs running an even shorter duration profile."
They write, "There's also the issue of European MMF reform which is supposed to come into place on January 21, 2019 for existing funds. In general, we are not expecting significant redemptions to take place out of offshore USD prime MMFs. European regulators have ruled that offshore prime MMFs, which are currently CNAV, can convert to either a low volatility prime MMF (LVNAV) or a variable prime MMF (VNAV)."
The piece continues, "Government MMFs remain CNAV. Furthermore, liquidity fees and gates would be applied to both government CNAV and prime LVNAV MMFs. As a result, we suspect shareholders will likely stay put, as opposed to moving their cash from prime MMFs to government MMFs. However, to the degree that it prompts some outflows before the end of the year, this could also encourage offshore prime MMFs to further shorten their duration profile."
J.P. Morgan Securities comments, "MMF inflows should continue. Throughout the course of this year, MMF flows have been atypical relative to years past. YTD, MMFs have seen outflows of $49bn, compared to $96bn of outflows that normally occur by this time of year.... Not surprisingly, most of the flows have been driven by institutional MMFs, and little by retail MMFs."
They explain, "Part of the story is likely tax repatriation related, as corporations look to build more liquidity in their cash portfolios in anticipation of putting the cash to use in the near-term. But another part of it is likely due to deposits being repositioned in the financial system, driven either by banks looking to shed more non-operational institutional deposits or by corporations looking to pick up extra yield."
The piece tells us, "This makes sense: as the Fed has continued to raise rates, yields on MMFs are increasingly getting more competitive with bank deposit rates. Relative to deposit betas, MMF yields are much more sensitive to Fed rate hikes.... It's not surprising then that when we compare the year-over-year growth rate in institutional MMFs and institutional deposits over the past year, the growth rate of institutional deposits has slowed while that of institutional MMFs has increased recently."
Finally, they write, "Looking ahead to 2H18, as the Fed continues to raise rates, we suspect depositors will feel more compelled to shift their deposits into the money markets. To this end, we wouldn’t be surprised if we see overall MMF balances increase in 2H18, above and beyond the seasonal inflows that would typically take place during this time period, creating demand for money market products. Over the past six years, MMFs have seen on average about $150bn of inflows in 2H."
