Last week, Crane Data hosted its Money Fund University annual "basic training" event, which featured two afternoons of online sessions, as well as number of recorded segments. One of the highlights featured J.P. Morgan Securities' Teresa Ho presenting the "Instruments of the Money Markets Intro." She gave an overview of the money markets, reviewed the major securities owned by money market funds, and presented an overall supply outlook. (Note: Crane Data Subscribers and Money Fund University Attendees may access the Powerpoints and recordings via our "Money Fund University 2022 Download Center.")
She tells us, "I'm here to give an introduction to the instruments of the money markets.... The money markets refer to a part of the fixed income markets whose securities mature inside of 13 months or less. It is high quality, it is low credit risk, and clearly because of both of those things, they don't yield a lot relative to the longer end of the credit curve.... This is a very, very large market.... Borrowers use it as a way to help finance their expenses on a short-term basis. Investors use it as a way to invest cash on a temporary basis, and then others use it as a way to manage their interest rate risk.... As long as there's demand for liquidity and as long as there's a mismatch between incoming and outgoing cash flows, there is a need for the money markets."
Ho continues, "What's interesting is that while it was a fairly mundane part of the market back in the day. I think what we have found out, given all of the recent financial crisis that we've come across, is that just how integral this part of the market is to the rest of the fixed income markets, particularly as it relates to how benchmarks like Fed funds, SOFR and LIBOR trade, as well as in the plumbing of monetary policy."
She explains, "So just to give you a sense of all the different types of borrowers ... the list ranges from banks to the U.S. government to U.S. municipalities to corporates and GSEs. But by far, in terms of instrument types used, the majority of the money markets are dominated by banks. They access the market not only in the form of commercial paper, but also in Fed funds in the interbank market. Is it certificate of deposits, time deposits, as well as certain types of derivatives like Eurodollar futures.... From what we can gather in terms of supply in the money market, we estimate that banks currently represent about 30% of the entire market, which at face value may seem like a lot. But ... that is a far cry from where supply was in 2007 and 2008."
Ho comments, "Slide #3 is a chart of our best estimate of the size of the money markets, and so that includes all the instruments that are inside of 13 months. In early 2008, you can see there are that total supply with around $11.5 trillion dollars. If you exclude Treasuries, just talking about credit supply, that number was closer to $9.5 trillion. Today, those figures are closer to $12.5 trillion and $6.0 trillion, respectively, which means that over the past ... 15 years or so, credit supply has fallen by a dramatic $3.5 trillion, while Treasuries has grown by about $6.0 trillion."
She states, "The Treasury story's easy to explain. It was fueled by the growth in the government's budget deficit over the past couple of years, particularly as it relates to all the recent stimulus that we've seen.... Conversely, as it relates to credit supply, this contraction ... was driven by banks ... because they over relied on the money markets back in 2007 and 2008 [which] forced them to de-lever during the global financial crisis. The post regulatory environment also exerted a lot of pressure on the banks to reduce their balance sheets. More recently, given all of the liquidity that's been injected into the financial markets ... there's just not a lot of need on the part of banks and nonfinancial corporations to borrow in the money market. So all of this has really resulted in a pretty dramatic reduction in credit supply in the money market."
Ho tells MFU, "If we just look at the commercial paper market over the years, we have certainly seen some of these dynamics play out.... The market at its peak used to be around $2.0 trillion in size in 2006. Over 50% of that was in ABCP, or asset-backed commercial paper, which has historically been a very popular funding vehicle for banks to raise short term funding on behalf of their clients. But since the collapse of SIV's and bank issuance, the sector has significantly fallen."
She adds, "The same is true about repo, which has historically been also one of the largest sources of bank funding in the money markets. Generally, dealers use repo as a ways to raise cash to make markets. But this sector really suffered from tremendous liquidity pressure during the global financial crisis in 2008, causing the market to be half the size where it was pre GFC.... That being said ... we have seen some growth in the markets recently. I think that's in part driven by dealers getting more efficient in how they manage their balance sheets. So that's provided a little bit of growth in the marketplace."
Regarding Fed repo, Ho says, "At year end, total RRP usage was around $1.9 trillion. Money funds made up $1.7 trillion.... I can get into some of the reasons why that usage is so high, but that is certainly something to note.... Looking ahead, we're anticipating that this number stays pretty elevated as we continue on throughout the course of this year."
She then discussed, "Where money market supply could go this year," explaining, "The area that I want to point out is dealer repo, where we've penciled in uptake of $200 billion in balances. And part of the reason for that uptick is that, you know, with the Fed stepping back as a big buyer of the Treasury market.... [Regarding] the other products in the money market space ... agencies ... should seriously be flat year over year, GSEs from Fannie and Freddie. [With] CD and CP on the margin, we see maybe a small uptick in their issuance there.... So, you know, that's why we kind of have outstandings start to be relatively flat year over year. The same is true for non-financial CP."
Discussing money fund balances, Ho says, "I suspect the large banks will continue to actively try to push some of these products off the balance sheet. As far as where it could go, obviously government money market funds are the most likely substitute. For that reason, we do think money fund balances stay elevated as [they have] been through this year. The other reason is more organic.... We're forecasting four rate hikes this year. Obviously, money fund yields are much more sensitive to interest rate hikes, and deposit yields are not.... As we move through this year, we would naturally expect that money fund yields and deposit yields to diverge, and that gap is going growing wider and wider. And what that means is that there's likely going to be a natural pool for the money to kind of move away from banks and into higher yielding products like government money market funds."
Finally, when asked about MMF reforms, Ho answers, "Obviously, I think the industry was a little bit disappointed when swing pricing was included in the proposal. You know, going back through the comments in response to the report, I think there was universal opposition across the entire industry [on] swing pricing, and yet they included it. So, you know, it's unclear at this point. I think there's a lot of moving parts. In an interesting twist, one of the SEC commissioners actually resigned at the end of last year, and this SEC commissioner actually voted against the release of the money fund reform proposal. So, it's unclear kind of how they will move forward with only four SEC commissioners in place at the moment."
She explains, "If everything is adopted as proposed, I think naturally what you'll see is basically prime funds looking more and more like government money market funds. [This is] in large part because of the increased daily and weekly liquidity requirements.... The spread differential between these two products will likely converge. [T]here's a real question as to whether money stays in prime funds, given kind of the lack of a yield advantage.... From a rates perspective, I think the question that we've been getting is, 'Will the CP market survive?' We all know that prime funds have historically been a huge buyer.... To the extent that we see money flow out of prime funds, does that mean that there's less capacity on the part of banks and financial issuers to continue to issue in the market? We don't think that's the case."
Ho adds, "I think there's a real likelihood that the money kind of moves into government money market funds. But I also think [money will] move into ultra-short bond funds and bond funds and SMAs. We've seen over the past probably five-plus years [that] issuers have really made an active effort to diversify their funding.... Prime funds only represent about 14% of the market.... Corporations make up about a quarter. You've got local governments, you've got mutual funds ... even stablecoin issuers.... So there are a lot of other types of investors in the market. I think the CP market will evolve, but it will still be there."
