Last week, Crane Data hosted Money Fund University, our annual "basic training" event, which featured two afternoons of online sessions as well as number of recorded segments. (Note: Crane Data Subscribers and recent Money Fund University Attendees may access the Powerpoint and recording for the MFU in our "Money Fund University 2021 Download Center.") One of the highlights featured J.P. Morgan Securities' Teresa Ho presenting an "Instruments of the Money Markets Intro," an overview of the money markets and securities owned by money market funds. She tells us, "Borrowers use it as a way to help finance expenses on a short-term basis ... investors use it as a way to invest their cash on a temporary basis, and ... others use the sector as a way to manage interest rate risk. So, basically, as long as there is demand for liquidity, and as long as there is a mismatch between incoming and outgoing cash flows, there's a need for the money markets. While it was a fairly mundane market back in day, I think what we have seen with [both] the recent financial crisis in 2008, as well as the most recent Covid crisis ... is how integral [the money markets] are to the rest of the fixed income markets."
JPM's Ho explains, "To give you an idea of the different types of borrowers in the money markets ... the list ranges from banks, to U.S. government, to U.S. municipalities, to corporations, to GSEs. In terms of instrument types used, and instruments that are available, the majority of the money market is dominated by banks. They access the market ... in the form of commercial paper ... [and] also participate in the Fed Funds market, in the Interbank market; they access the market in the form of certificates of deposits and regular time deposits.... So, from what we can gather in terms of supply in the money markets, we estimate that banks currently represent about 30% of the entire money markets. Thirty-percent at face value may seem like a lot, but ... it's a far cry from where supply was in 2007 and 2008."
She comments, "[I]n early 2008, total supply was around $11.5 trillion. If you exclude Treasuries and just focus on credit supply, that number was closer to $9.5 trillion. Today those figures have diverged pretty dramatically. Total money market supply ... is at $14 trillion; if we're just talking about credit supply, that has dwindled to about $6 trillion. Which means that over the past 13 years credit supply has fallen by a dramatic $3.5 trillion, while Treasuries have grown by $6 trillion."
Ho continues, "The Treasury part of the story is easy to explain. Over the past couple of years it’s been fueled by the growth of the government budget deficit.... It grew significantly last year because of the Covid crisis.... Issuance in the very front end of the curve has dramatically pushed supply in the sector higher. Conversely, when we look at credit supply, it's seen a huge contraction in the space. As you would expect, a lot of that contraction was driven by banks. Post-2008, a lot of it was driven by banks because they were over reliant on the money markets prior to that..... This new regulatory environment ... is exerting a lot of pressure on the banks to reduce their balance sheet, to reduce their short-term wholesale funding, because they were overly relying on it. So we've seen dramatic shrinkage in the credit supply that banks are offering to the money markets."
She also tells MFU, "The same can be said about repo, which has historically been one of the largest sources of bank funding in the money markets. Generally, dealers use repos as a way to raise cash in the markets.... But this sector suffered tremendous liquidity pressure in the aftermath of the financial crisis, causing the market to be half the size of where it was years ago. There are a couple of reasons for that. The onslaught of banking regulations really is a reason why the market has shrunk so much. Whether we're talking about the leverage ratio, the liquidity coverage ratio, or even GSIP surcharge, all of these rules had an impact in the Repo markets by pressuring them to shrink their balance sheets and consequently their footprint in the money markets."
Ho states, "With that being said, even though the contraction has occurred, what we have seen, interestingly, is also a change in the underlying composition of the bank borrowers in this market. It has evolved pretty dramatically. Looking at the repo markets in particular, much of those exposures are now concentrated in foreign banks as opposed to U.S. banks. In fact, if you look at the top five counterparties with money funds, ... if we exclude FICC and just look at the top five counterparties, foreign banks basically represent 70% of those exposures. The reason why foreign banks have such a huge dominance in this market was really driven by how leverage ratios are being calculated."
She adds, "[I]t is interesting to note that the U.S. banks have also kind of come up in their exposures of money funds. This has largely been a result of banks getting more efficient in managing their balance sheets. One way that they have been able to do that is with the use of sponsored repo. Sponsored repo is a relatively new product offered by FICC.... [I]t allows dealers to basically net their reverse repos and repos off balance sheets.... If they are able to kind of match those two together on their balance sheet, they're able to net that off, and once it's netted off they don't have to pay leverage capital, or whole leverage capital against it. This allows dealers to offer more liquidity to the markets, and so it has become a very useful tool for the dealers and also the markets, to one, get liquidity and two, get capacity."
She also says, "Away from banks, if we look at other borrowers in the money markets, such as the GSEs, ... what we find is that there's a similar decline, particularly at Fannie and Freddie.... Offsetting this over the past couple of years has been an increase in the amount of Federal Home Loan Bank issuance.... The one outperformer ... has been Treasury bills. Even prior to last year, where Treasury significantly increased Treasury bill outstandings to fund the stimulus to the tune of about $2 trillion, they were already gradually increasing Treasury bill outstandings in the years leading up to it."
JPM's Ho comments, "[W]e are expecting slightly negative Treasury bill issuance over the course of this year; we're thinking $338 billion of a decline in Treasury bills. Most of the issuance is really going to be around coupons at $2.7 trillion. Net of the Fed purchases, that goes to $1.8 trillion. So, compared to the $2 trillion of Treasury bills that we saw last year, obviously this year we are seeing a lot less."
She says, "What we are anticipating is that overall supply balance is not really to increase meaningfully in the year 2021. In fact, we are looking for total supply to increase by only $41 billion next year and $80 billion <b:>`_when we're just talking about credit.... We did pencil in `growth in Repo balances by $175 billion to capture the growth in Treasury coupons.... But away from that, when you look at how much money is sitting at bank balance sheets and how much is sitting in corporate balance sheets, we just don't really see a need for real funding in those credit markets."
Next, Ho tells us, "Excess deposits have grown really dramatically over the past year. And bank CP/CD outstandings have actually just done the reverse. With so much cash on their balance sheets, with so many deposits on their balance sheets, and not really having a lot of assets that they can buy that make sense for them because really nobody is borrowing a lot of loans right now, there's just no need for the banks to go out and tap the CP/CD markets for funding."
She explains, "At the same time, when we switch and look at non-financials.... What you find there is you have a situation where non-financials are finding issuance out the curve to be a much more attractive opportunity for them. Instead of buying and borrowing in CP at 20 basis points, they can basically go out to two years and borrow money there at around 75 basis points. We are not anticipating non-financials to really see a need to borrow in the CP/CD market, and as a result, we're just not going to see a lot of credit supply this year."
Finally, Ho asks, "So why does that matter? It matters because when we look at the demand side of the equation, the cash investor side of the equation, that continues to go up, and you can see that in deposits, you can see this in the balances of government money funds.... In the context of just looking at supply and demand, you have a situation where there's a lot of demand for money market assets, but you have a situation where money market assets are actually just declining. That matters clearly because when that happens, rates are going to be compressed, spreads are going to be compressed and yields are going to be very, very low, particularly as you tack on what the Fed is doing with its interest rate policy. It's going to be a challenging year for the money markets to stay invested and basically earn yield in the money market."
