Citi's Kang on Negative Rates, MMFs
Citi Research's Steve Kang writes about "Negative rates and money markets" this week, explaining, "NIRP was implemented by the ECB and BoJ in June 2014 and January 2016, respectively.... MMFs in both regions seems to have weathered the storm -- with AUM dropping only briefly and then recovering later.... However, the US requires more caution, as it is much more reliant on MMFs than other areas -- US MMF AUM is 21% of nominal GDP, 4% for Euro (EUR ccy), and 2% for Japan. Also, US MMF is much more government focused -- 82% of total notional is government-only versus mostly credit in Europe and Japan." Kang continues, "Once the ECB instituted ZIRP in 2012, major EUR MMF providers closed their funds to new investments. In response to NIRP in 2014, the community initially responded by instituting a reverse distribution mechanism (RDM) whereby the funds [sell shares to cover expenses] rather than lower $1/share CNAV as a way to pass through negative rates to end users. In January 2018, the EC ruled that RDM is not compatible with the EUR MMF reform -- which made keeping CNAV untenable for negative rates, forcing EUR-denominated MMFs to convert into Variable NAVs (VNAV) instead." He adds, "The NAV stability has traditionally been an important attribute for US investors for accounting/operational reasons. With VNAV unlikely to be a palatable option for US cash investors in the near term, US MMFs are likely to resort to RDM to keep CNAV, and the Fed is likely to allow it to avoid disruption in this market. RDM doesn't seem to be explicitly banned in the US for now -- but it is possible to be reviewed at a later date once things are calmer. Even if RDM is allowed and MMFs are ready, some lead time is necessary for end users of MMFs for a smoother transition. In general, the conversation around negative rates still seems preliminary between MMFs and cash investors. There are also likely to be other frictions that we are not aware of on payment flows. As discussed earlier, the size of the UST supply warrants ample caution on the changing MMF landscape. In other words, though it is a solvable friction, MMF logistics wouldn’t allow the negative rates to be implemented this year." Goldman Sachs Asset Management's Patrick O'Callaghan also was asked about negative rates during a webinar recently. He replied, "[I]t's definitely something that we're hearing a lot from clients.... We've already seen negative rates here through the month of March with T-bill offers in the secondary market going negative.... Our base case is that the Fed will not take policy rates negative.... The fact that they're leaving policy rates at the zero lower bound right now signals to us that they are most likely going to keep them there.... I think if the Fed wanted to be below zero we would be there already.... Can market rates go negative even if the Fed doesn't take policy rates negative? ... Obviously yes, because we saw it happen at the end of March. That has [now] largely reversed itself.... We have a tremendous amount of supply coming into the market. Now, that supply is being met with demand because of this huge influx into government and treasury funds. We'll see how long both of those things last." O'Callaghan adds, "Then there are other things that fund companies can do and we have seen some of that already.... You have seen soft closures to new investors, which would obviously limit transactions at rates below the fund's net yield. You will probably see, if we get into a world in which we continue to migrate closer to the zero-lower bound, fee waivers. Then potentially you can see hard closures of purchases, not redemptions, in Government or Treasury products to again limit dilution of the fund's yield to that negative yield standpoint.... But I think with the backdrop of ever-increasing T-bill supply market rates should stay on the plus side of the equation for quite some time."
