Late last week, Crane Data hosted its "basic training" conference, Money Fund University in Providence, R.I. J.P. Morgan Securities' Teresa Ho presented the "Instruments of the Money Markets Intro," and gave an overview of the money markets and securities owned by money market funds. She tells us, "Borrowers use [the money markets] as a way to finance their short-term expenses, and investors use [it] as a way to temporarily invest their cash. Others use it as a way to manage their interest rate risk. Basically, as long as there's a demand for liquidity and as long as there's a mismatch between cash inflows and cash outflows, there is a need for money markets.... I think what happened in 2007 and 2008 has shown us just how interwoven money markets are with the fixed income markets, especially as it relates to how repo is traded on a daily basis, how Fed funds get traded on a daily basis as well as LIBOR." (Note: Crane Data Subscribers and recent Money Fund University Attendees may access the Powerpoint and recording for the MFU in our "Money Fund University 2020 Download Center.")
JPM's Ho explains, "To give you an idea of the different types of borrowers participating in money markets ... the list ranges from banks, to the U.S. government, to municipalities, to corporations, to GSEs, but by far the majority of the money markets are dominated by banks. They access the market not only in the form of commercial paper, time deposits, Fed funds, via the interbank market, and repo, but also via Eurodollar futures. From what we can gather about supply in the money markets, we estimate that banks make up about 35 percent of the entire money markets.... It seems like a lot, but that's a far cry from where we were in 2007 and 2008."
She comments, "At its peak in early 2008, total supply peaked at around $11.5 trillion dollars. If you exclude Treasuries, now we're just talking about credit supply, that number was closer to $9.5 trillion. Today those figures are closer to $10 trillion and $5.9 trillion, respectively. Which means that over the past 12 years, as far as credit supply goes, it's fallen by a dramatic $3.7 trillion. A lot of that, as you would expect, was driven by banks. They were overly reliant on short-term, wholesale funding, and they had to deleverage significantly after the crisis. But I would say even more so, the regulatory environment has been exerting a lot of pressure."
Ho tells us, "The same could be said about repo, which has historically been one of the largest sources of funding for a lot of the banks, both foreign and domestic. This is the sector that suffered tremendous liquidity pressure during the financial crisis, and today it's basically half the size of where we were in 2007 and 2008.... That being said ... I think over the past two years we have seen a little bit of growth in the repo markets, largely aided by the increase in Treasury issuance ... and dealers getting more efficient in terms of how they fund their balance sheets. Both of these things have prompted repo balances to increase over the past 24 months. But again, if you compare back to where it was in 2007 and 2008, it's still a far cry from where we were."
She states, "One of the things that's happened in money markets is the evolution of the composition of borrowers in the market. When we look at the underlying composition, what we have seen is that foreign banks have increasingly dominated the space. Just looking at the repo market ... you can see that foreign repo counterparties make up about 65 percent of the top five counterparties. This demonstrates just how much foreign banks are being involved in the money markets."
Ho adds, "Another driver ... is development of sponsored repo. This is a new development that's come to market over the past couple of years. It's a way for dealers to basically net the reverse repos or repos off balance sheet. So they're able to basically source this funding in the repo market without having an impact on their balance sheets. And it's been very successful.... At the end of December, it was even higher at around $250 billion. [At] yearend, there's always a lot of balance sheet concerns, a lot of window dressing, [and] using FICC sponsored repo is a way for the dealers to basically continue that funding without having an impact on all those regulatory ratios. It's certainly provided relief for the markets in having this particular product."
She also says, "Away from banks, when we look at the other borrowers in the money markets, such as the GSEs, we've actually seen a similar decline in the space as well, the likes of Fannie and Freddie.... Offsetting this, though ... has been balances at Federal Home Loan Banks.... The one outperformer ... is Treasury bills.... Over the past three years, outstandings have grown by almost $1 trillion."
JPM's Ho comments, "In terms of how we think about money market supply balances for the year 2020, we're projecting an increase of $345 billion this year, which is an increase of 3.0 percent. This is the lowest increase that we've seen in the past three years. Again, a large part of that moderation is because we're seeing that negative bill issuance in the marketplace.... We're also expecting dealer repo to only increase by $100 billion next year, in part because with the Fed coming in and buying all these Treasury securities there's less securities that the dealers are actually holding on their inventory. With less inventory on their balance sheets, there's actually less need for financing on the dealer side. When you think about those two things, those two things are basically driving our money market supply balances this year, much lower than we've seen over the past couple of years. As far as the other sectors go, between agencies, and CP, CD, and bonds that are rolling into the money market space, kind of small increases here and there, nothing really dramatic."
Next, Ho tells us, "Money funds, obviously are a very big buyer of money market supply. And if we look at how these cash balances evolved over the past year ... they've had just phenomenal growth. I think [for] 2019 ... balances grew by over $500 billion. I would say there's a couple of reasons for that growth. One, I think with the inversion of the yield curve last year, a lot of people just didn't want to extend duration. They wanted to be in a short duration space to maintain their higher yield. I think the second reason is that we saw a lot of volatility in the marketplace, both on the equity side and fixed income side.... It was a good place for some investors to hide out in the money markets without having a lot of volatility and still get that higher yield."
She adds, "I would say the third reason why we saw a lot of cash going into the money funds is because even when we think about what happened with interest rates, where the Fed decreased interest rates three times, when we compare bank deposit yields versus where money fund yields were offering, there was still a pretty substantial gap between these two products. On the margin, we also saw some savers out there that actually shifted their cash from bank deposits into the money funds. All of that drove money into the money fund space.... All that money went into Treasuries, it went into agencies, it went into repo, as well to bank CP, CDs."
Ho explains, "As we look forward to 2020 ... are we anticipating the same growth in the money fund space? ... I think we will continue to get positive growth. I'm not sure we're going to get as much as we saw last year, but certainly I think, the trajectory is for more inflows that come into the money funds. Going back through those same three reasons I just talked about with the curve, the curve is not inverted anymore, but it's still pretty flat. I would say investors are still not very much incentivized to go out and take duration risk when they're not taking that much extra yield. So, again, the short end is a place where they could hide out for the time being. We're still seeing some sort of volatility in the marketplace."
Finally, she states, "Despite all the changes that we've seen, I would say the money markets are here to stay. As I said at the beginning, as long as there is a demand for liquidity, as long as there's a mismatch between cash inflows and cash outflows, money markets will continue to exist. Certainly, regulations have changed the structure, but as you can see with some of the products that are coming onto the market, the markets have adapted to that.... The money markets are not going away anytime soon."
