Invesco, JPM on Negative MMF Yields; ICI: March Record Asset Madness

Mar 27 20

Now that the danger of a money fund "breaking the buck" or a run on Prime assets has passed (knock on wood), attention in the cash sector is turning to the next potential threat -- negative yields. Earlier this week, Invesco Fixed Income's Laurie Brignac and Rob Corner wrote, "Negative Rates: Could it happen in the US?" They explain, "Questions about the possibility of negative rates in the US have arisen due to the quick and pivotal actions of the US Federal Reserve (Fed) prompted by the economic impact of COVID-19 and subsequent sharp decline in US Treasury yields. We believe the probability of the Fed adopting a negative interest rate policy (NIRP) regime is highly unlikely in the near-term.... Perception of the Fed moving to negative interest rates would cause confusion and even more market upheaval. The Fed has said it's unlikely and raised questions about adverse effects.... `Last, a switch by the Fed to a negative interest rate regime would likely significantly impact the US money market fund industry, which is an outcome we believe policy makers do not want."

Invesco's note continues, "Negative yielding, short-term US Treasury securities have occurred historically in the US, very briefly, at key month and quarter-end dates but have not been pervasive in the US markets. More recently, however, we have seen US Treasury securities offered at negative yields across much of the short-term maturity spectrum. We believe the Fed and US Treasury could actively intervene to avoid negative rates from persisting at the short end of the yield curve."

They explain, "The US money market fund industry has already operate efficiently in a zero, or near zero, interest rate environment through waivers and expense reductions. Invesco successfully navigated this environment from 2009 to 2015. If negative rates we to occur and persist and gross yields on money market funds fell below zero, money market funds could implement, with guidance and approval from the Securities and Exchange Commission (SEC), reverse stock splits or reverse distribution mechanisms (RDM) such as share cancellation. Although the SEC has not provided guidance with regards to RDM, Invesco is prepared to adopt this method in the US if negative rates become a reality."

Invesco's piece adds, "We believe an industry shift to RDMs would not happen quickly. Regulatory guidance and disclosures would need to be communicated, systems may need to be updated and clients would need an advance notice period for an orderly transition. Under this regime, money market funds would continue to transact at a $1.00, using RDMs like share cancellation. In our opinion, this scenario is extremely unlikely as we belief it is a path that policy makers do not want to walk."

In mid-March, J.P. Morgan Securities also commented on negative yields in their "Short-Term Fixed Income" and asked, "What happens at zero?" They explain, "We think negative policy rates are unlikely, even in a very weak environment. Not only because there is some question as to whether the Federal Reserve Act even permits the Fed to charge interest on reserves, but also because Congress and the public would surely push back against negative interest rates."

The piece states, "In December 2008, the Fed lowered policy rates to the effective lower bound of 0.00%-0.25%, setting IOER at 0.25%. The decision to move to a range was in large part due to uncertainties around money market functioning at very low levels. However, in the following seven years that the Fed kept rates at the lower bound, domestic money market functioning was generally orderly. To be sure, the decision on the part of MMF managers to waive MMF fees helped significantly. Even as MMF gross yields plummeted to the single digits, MMFs still eked out barely noticeable net positive returns to shareholders.... Managers effectively absorbed the costs of running a MMF to avoid negative yields, and kept cash within the MMF industry. We suspect MMFs will look to waive fees again this time around, and thus give the Fed some comfort that the money markets will continue to function even if IOER falls to zero."

JPM adds, "That said, it's worth noting that the money market industry has changed considerably since rates were previously at the zero lower bound. More specifically, $1tn of cash has moved from prime to government MMFs as a result of MMF reform in 2016. More recently, cash has continued to pile into MMFs, particularly into government MMFs, as markets de-risk and the inversion of the yield curve has prompted investors to stay very short duration.... This means there is significantly more demand for T-bills and Treasury repo now than ever before."

Finally, they tell us, "[C]an MMFs go negative? In Europe, where negative rates have become the norm, MMFs have successfully coped with negative yields by employing a reverse distribution mechanism (RDM). This method allows MMFs to pass on negative interest rates to underlying shareholders by cancelling shares instead of directly charging shareholders. The assets of the cancelled shares are then split among the remaining ones, ensuring that the value per share remains at par or stable, and doesn't break the buck. The tool has proven successful in maintaining cash in EUR-denominated MMFs prior to European MMF reform. Presumably, US MMFs could employ a similar strategy for government MMFs but given the significant market size differences, it may be easier said than done. Not to mention, this is probably something that the SEC, the regulator for MMFs, would likely need to opine on."

In other news, money market mutual fund assets again surged to record levels in the past week, though the inflows didn't match the previous week's massive $285.7 billion inflow. (It was the second largest inflow ever though.) ICI's latest weekly "Money Market Fund Assets" report explains, "Total money market fund assets increased by $175.29 billion to $4.40 trillion for the week ended Wednesday, April 1, the Investment Company Institute reported.... Among taxable money market funds, government funds increased by $173.75 billion and prime funds decreased by $4.69 billion. Tax-exempt money market funds increased by $6.24 billion."

ICI's stats show Institutional MMFs rising $162.7 billion and Retail MMFs increasing $12.6 billion. Total Government MMF assets, including Treasury funds, were $3.613 trillion (82.2% of all money funds), while Total Prime MMFs were $654.3 billion (14.9%). Tax Exempt MMFs totaled $129.9 billion, 3.0%. Money fund assets are up $765 billion, or 21.1%, year-to-date in 2020, and they've increased for 8 weeks in a row and in 12 out of the last 15 weeks. Over the past 52 weeks, ICI's money fund asset series has increased by $1.290 trillion, or 41.5%, with Retail MMFs rising by $305 billion (25.0%) and Inst MMFs rising by $985 billion (52.2%).

They explain, "Assets of retail money market funds increased by $12.60 billion to $1.52 trillion. Among retail funds, government money market fund assets increased by $12.93 billion to $976.29 billion, prime money market fund assets decreased by $4.82 billion to $430.84 billion, and tax-exempt fund assets increased by $4.49 billion to $116.88 billion." Retail assets account for over a third of total assets, or 34.7%, and Government Retail assets make up 64.1% of all Retail MMFs.

ICI adds, "Assets of institutional money market funds increased by $162.69 billion to $2.87 trillion. Among institutional funds, government money market fund assets increased by $160.81 billion to $2.64 trillion, prime money market fund assets increased by $131 million to $223.47 billion, and tax-exempt fund assets increased by $1.74 billion to $13.06 billion." Institutional assets accounted for 65.3% of all MMF assets, with Government Institutional assets making up 91.8% of all Institutional MMF totals.

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