Last week, we published excerpts from our latest online event, "Crane's Money Fund Webinar: Portfolio Holdings Update." (See our July 2 News, "Crane and Ho Discuss Inflows, Waivers and Prime Exits on 2nd Webinar.") The session, which featured Crane Data's Peter Crane and J.P. Morgan Securities' Teresa Ho, discussed the latest trends in the money fund space with a focus on recent Money Fund Portfolio Holdings data. Today, we highlight the second half of the webinar. Readers may access the video recording and materials via our Webinar page here. (Also, register for our next event, "Crane's Money Fund Webinar: Portfolio Manager Perspectives," which is scheduled for Wednesday, July 22 at 1:00pm (EDT). It will feature our Peter Crane hosting a panel of PMs, including Federated Hermes' Sue Hill, Northern Trust Asset Management's Peter Yi and UBS Asset Management's David Walczak.)
On Portfolio Holdings, JPM's Ho tells us, "Shifting over to the bigger story that we've seen in the money fund space, it's just a pivot into Treasury bills.... Money funds now basically across the govie space and across the prime space, collectively, they now represent about 45 percent of the Treasury bills market, which is very significant. Historically, they've been running more about 25 percent. But over the past two months, they've definitely significantly raised their percentage in the amount of Treasury bills that they hold.... I think initially part of the reason why they took down so many bills was because of the surge in govie funds that we saw in March and April."
She continues, "What we've seen past March and April is that the pivot into Treasury bills has really expanded beyond the government money market fund space and into prime money funds as well. Part of the reason why that was taking place is that prime funds are still somewhat uncertain about their liquidity. They're still uncertain whether they're going to see more outflows down the road. There are a variety of things -- potentially a second wave coming down later this year, or rating downgrades -- that could prompt certain investors to pull their money out of prime funds.... I think the March incident has taught them that they need to hold more liquidity than they may even have before the pandemic. If you look at where liquidity is right now, for a lot of the prime funds on average, I think they're holding about 50 percent of the portfolio in what they call the seven-day liquidity bucket, and that bucket includes a lot of Treasury bills ... and any CP and CD that matures within seven days. That is another reason why the prime funds were kind of pivoting away from CP/CD and into Treasury bills."
Ho adds, "Away from the liquidity concerns, more recently, I think what you've seen is the very rapid collapse in the spread between Libor and OIS, and as a result between Libor and T-bill yields. It's just the relative value between these two products, one of which is a risk free product and the other a credit product, have collapsed to the point where investors were just starting to feel that they weren't being fairly compensated for taking on that credit risk."
She comments, "If you think about where spread in Libor is today ... T-bill yield in the three-month sector has been trading around 14-15 basis points. So, for an extra 15 basis points, you're buying CP/CD in the three-month space. On a relative basis to where that spread has been between T-bills and CP/CD, that's fairly tight at 15 basis points. So, a lot of investors are saying, I just don't see the value right now in putting my money in CP/CD.... What they're doing instead is just buying more bills.... The percentage of bills as a percentage of the entire portfolio with respect to prime funds is close to 30 percent. With respect to govie funds it's close to 45 percent. That's the highest that ... we have ever seen in terms of Treasury holdings. Definitely, that is kind of the big story of the past couple months and I suspect it will continue to be the case as we had into the second half of this year."
Ho also explains, "While we've had a surge in the supply of Treasury bills coming through the past couple of months, we are anticipating ... that to be gradually wiped out. The reason for that is because at the last Treasury refunding announcement in early May, what Treasury has told us is that they will likely gradually shift their debt issuance more toward coupons.... So, what will happen gradually going forward is that the supply of Treasury bills will gradually come down as they shift more of their insurance towards Treasury coupons. And what that would mean is that for a lot of these funds that are holding Treasury bills now, it may be a little bit more of a challenge to get hold of these bills."
She states, "That's the dynamic that we're watching as far as where Treasury bills end up trading in the second half of this year. It's that relationship between the amount of Treasury supplies coming through and the demand for Treasury bills from govie funds. That's not to say that Treasury bills are going to cheapen significantly or rally significantly. I think what we have learned over the past couple of months is that there are a lot of people that want to buy bills, especially in the current period where there's just so much liquidity out there.... There is more than $3 trillion in Reserves, a lot of it is sitting at large bank portfolios. And so, they're going to be opportunistic, and if bills do widen to a point where it's attractive for them, they're going to come in and start buying Treasury bills. You can always see them as kind of a backstop buyer for Treasury bills in the event that money funds are not there."
Ho continues, "When I mentioned the pivot to Treasury bills earlier.... It was also coming out of Repo as well. Where Treasury Repo was trading on the tri-party side of an overnight basis, they were kind of trading between six to eight basis points. So relative to three-month bills which were trading 15, obviously, there was a lot more spread pick up to go into Treasury bills. So, we've seen the amount being allocated to Treasury Repo come down over the past month. Just for Treasury funds, their Repo allocation came down by $43 billion last month. And, we've seen a $24 billion increase in Treasury bill allocation. On the govie fund side ... the drop in Treasury allocation was a lot bigger. We've seen a reduced exposure to Repo across the money fund space because of that relative value, because they were just not as attractive as where bills were trading. Normally that will be an issue for the dealers just because of how much money funds extend financing to the dealers in the form of Repo. But in this instance it's less of an issue for the dealers, unlike the episode we saw last September, because the Fed has stepped in as the buyer, basically removing a lot of collateral and removing a lot of positions and inventories off of dealer balance sheets."
Crane asks, "I was going to ask you now on our last segment to talk about the other CP buyers.... What happened last time was you had prime funds shrink, but it seems like the demand didn't shrink as much. You had other buyers materialize in that ultra-short space, in the private liquidity fund space outside of money market funds. I don't expect a substantial shrinkage in prime, but if you do get it, I'm encouraged for the issuers point of view that other buyers may step forward."
Ho answers, "Outside of prime funds, ultra-shorts and ultra-short bonds funds are clearly also big buyers of CP/CD. They, like prime funds, saw liquidity issues back in March. They probably didn't experience as big of a withdrawal as prime funds, but regardless, I think from just being a conservative standpoint, they were not willing to extend lending to corporate or bank CP/CD out the curve. And they, like everybody else, wanted to focus more on the shorter tenure. They have been a sector that has grown a lot over the past couple of years. So, they've been able to kind of provide funding for a lot of these banks and corporations. Outside of them, there are what we call securities lenders, there are cash reinvestment portfolios that also invest in a lot of bank CP/CD and non-financial CP. Then you have the state and local governments, they have to manage their own liquidity portfolio like anybody else, and they tend to invest in CP/CD and ABCP."
She continues, "I think what we learned last time from the Money Fund Reform, at least in the issuers' perspective, is that they need to diversify away from just relying on prime money funds as a source of liquidity. And so, they did that. They started branching out to the state and local governments. They're talking to some of the more sophisticated corporations that manage their own cash portfolio.... They have diversified their funding sources. And, unfortunately, back in March, pretty much everyone across the board was kind of experiencing the same liquidity issue or market to market issue. And so, most people weren't as willing to lend out during that time period, which is why the Fed had to step in with the Money Market Liquidity Facility and CPFF. We focus a lot on the money funds, but frankly, in the prime fund space, we have to be cognizant that they are not the only buyers of CP/CD and the others do matter a lot as well."
Finally, Ho says about potential regulatory reforms, "I'm sure at some point down the road they're going to think about what went wrong, what went right, what they could do better. I think in some ways the 30 percent liquidity threshold was kind of a coolant to breaking the buck. I think that was the thing that incentivized a lot of people to kind of arm their cash earlier on before a fund hit that 30 percent threshold. I think there's been talk about potentially setting up some sort of permanent facility from the Fed that in the event that these things do happen. We wouldn't have to wait a few days for the Fed to basically set everything before the money funds could access that.... You just wonder, again, if the money funds will be willing to take on that additional cost for that liquidity backstop.... When you think more broadly in terms of what happened in March and April, the Fed had to step in not only for the money fund industry, but across the board. So, they're going to be working on a lot of other things and thinking about a lot of other markets and how they can do better. There could be more down the road, I don't know exactly what it's going to be."
