Another new academic research paper involving money market funds, entitled, "The Imperfect Intermediation of Money-Like Assets," was recently published by Jeremy Stein of Harvard University and NBER and Jonathan Wallen of Harvard Business School. Their "Abstract" explains, "We study supply-and-demand effects in the U.S. Treasury bill market by comparing the returns on T-bills to the administered policy rate on the Federal Reserve's reverse repurchase (RRP) facility. In spite of the arguably more money-like properties of an investment in RRP, we observe repeated episodes where one-month T-bill rates fall well below expected RRP rates. This gap frequently exceeds 50 basis points in 2022, before spiking to over 160 basis points during the initial period of uncertainty over the debt ceiling in March and April of 2023." (Reminder: Register ASAP for our European Money Fund Symposium, which takes place Sept. 25-26, 2024 in Edinburgh!)

It continues, "In an effort to understand this phenomenon, we develop and test a simple model where the RRP-bill spread is policed by a group of heterogeneous money funds, who differ in their elasticity of substitution between the two assets. Our main finding is that when T-bills are scarce, and the spread is large, the marginal money fund is more inelastic, as the more elastic funds have already exhausted their holdings of T-bills. As a result, for a given shift in T-bill supply, the effect on rates is an order of magnitude larger when T-bills are scarce, and when more money funds are out of the market."

The paper's "Introduction" comments, "A growing literature emphasizes how the frictions and constraints associated with financial intermediation can influence the behavior of asset prices. In this paper, we apply a frictional-intermediation lens to study pricing anomalies in the U.S. Treasury bill market, where money-market funds are among the most important players. However, unlike much of the work in this area, which focuses on the behavior of a single representative intermediary, we emphasize heterogeneities in the responsiveness of different money funds to supply and demand shocks in the T-bill market. We show that these heterogeneities play a crucial role in shaping the price impact of such shocks."

It tells us, "More specifically, we compare the returns on T-bills to those on another safe money-like government claim, namely an investment in the Federal Reserve's reverse repurchase (or RRP) facility. The RRP facility allows a pre-approved group of eligible counterparties, including primary dealers, government-sponsored enterprises, and a set of roughly 140 money-market funds, to lend to the Fed on an overnight basis against Treasury collateral, at an administered policy rate. Both of these markets are large, with $4.5 trillion in T-bills (excluding T-bills held by the Fed) and $1.8 trillion in RRP outstanding as of July 31st 2023."

The authors write, "Figure 1 displays the one-month realized and ex-ante expected returns on the RRP facility alongside the rate on one-month T-bills, over the period from June 2021 to July 2023. A priori, one might have guessed that the expected RRP rate would be a lower bound on the T-bill rate. Both instruments have the full backing of the U.S. government, and hence are free of credit risk. Moreover, in addition to having zero duration and hence no exposure to interest-rate risk, an investment in RRP can also be said to be more purely money-like than one in T-bills, since it liquidates and hence can be monetized at zero cost on an overnight basis; by contrast, to monetize a T-bill overnight would require selling it and thereby accepting some bid-ask cost. These differences should in principle translate into a weakly lower rate of return on the RRP as compared to T-bills."

They comment, "Yet, as Figure 1 shows, this hypothesis is violated in the data, sometimes dramatically so. While T-bill and expected RRP rates are nearly identical from June 2021 through early 2022, after that they begin to diverge, with one-month T-bill rates falling well below expected RRP rates. This gap frequently exceeds 50 basis points in 2022, before spiking to over 160 basis points during the initial period of uncertainty over the debt ceiling in March and April of 2023."

The paper states, "In an effort to understand this puzzling behavior, we zero in on two types of frictions that can impede the seemingly simple arbitrage that would appear to be available whenever T-bills offer a lower return than that on the RRP facility -- namely, one would expect anyone holding the lower-yielding T-bills to sell these T-bills and to replace them with an investment in the RRP. The first friction is a form of market segmentation created by the fact that the Fed's RRP facility is not available to all investors. Rather, as noted above, access is limited to primary dealers, GSEs, and a select group of money funds, with money funds being by far the dominant participants in the facility, holding on average about 90 percent of the outstanding volume of RRP."

It adds, "This paper aims to make two contributions. First, and most concretely, we hope to shed some light on the factors that influence rate dynamics in one of the most important money markets in the world, the market for Treasury bills. The movements in spreads that we document have obvious first-order consequences for the U.S. government's borrowing costs, as well as for any other borrowing rates that are tied to T-bills, such as those on adjustable-rate mortgages. And the fact that T-bill rates can become quite disconnected from the rate paid by the Fed on its RRP facility would seem to suggest that the RRP facility as currently designed is not fully living up to the Fed's articulated goal for it, which is to put a floor on all short-term money-market rates. On the Federal Reserve Bank of New York's website, a description of the program says that: 'The [RRP] provides a floor under overnight interest rates by offering a broad range of financial institutions that are ineligible to earn [interest on reserve balances] an alternative risk-free investment option.'"

Finally, they say, "At a second, and somewhat more general level, we hope to contribute to the broader literature on intermediary asset pricing by highlighting the role of heterogeneity among intermediaries, and the implications this heterogeneity has for the responsiveness of asset prices to various shocks."

In other news, Crane Data published its latest Weekly Money Fund Portfolio Holdings statistics Wednesday, which track a shifting subset of our monthly Portfolio Holdings collection. The most recent cut (with data as of Sept 1) includes Holdings information from 54 money funds (down 24 from a week ago), which totals $2.307 trillion (down from $3.102 trillion) of the $6.010 trillion in total money fund assets (or 38.4%) tracked by Crane Data. (Our Weekly MFPH are e-mail only and aren't available on the website. See our latest Monthly Money Fund Portfolio Holdings here.)

Our latest Weekly MFPH Composition summary again shows Government assets dominating the holdings list with Repurchase Agreements (Repo) totaling $1.188 billion (down from $1.628 trillion a week ago), or 51.5%; Treasuries totaling $743.7 billion (down from $909.8 billion a week ago), or 32.2%, and Government Agency securities totaling $186.1 billion (down from $254.1 billion), or 8.1%. Commercial Paper (CP) totaled $61.9 billion (down from a week ago at $104.8 billion), or 2.7%. Certificates of Deposit (CDs) totaled $54.8 billion (down from $84.5 billion a week ago), or 2.4%. The Other category accounted for $51.0 billion or 2.2%, while VRDNs accounted for $21.8 billion, or 0.9%.

The Ten Largest Issuers in our Weekly Holdings product include: the US Treasury with $743.7 billion (32.2% of total holdings), the Federal Reserve Bank of New York with $583.3 billion (25.3%), Fixed Income Clearing Corp with $155.1B (6.7%), Federal Home Loan Bank with $140.6B (6.1%), JP Morgan with $46.4B (2.0%), Barclays PLC with $37.8B (1.6%), Federal Farm Credit Bank with $37.5B (1.6%), Goldman Sachs with $34.6B (1.5%), Citi with $33.7B (1.5%) and BNP Paribas with $33.6B (1.5%).

The Ten Largest Funds tracked in our latest Weekly include: Goldman Sachs FS Govt ($260.0B), JPMorgan US Govt MM ($259.5B), Morgan Stanley Inst Liq Govt ($159.4B), JPMorgan 100% US Treas MMkt ($156.5B), BlackRock Lq FedFund ($136.6B), Allspring Govt MM ($119.5B), State Street Inst US Govt ($114.2B), Dreyfus Govt Cash Mgmt ($107.7B), BlackRock Lq Treas Tr ($102.7B) and BlackRock Lq T-Fund ($93.8B). (Let us know if you'd like to see our latest domestic U.S. and/or "offshore" Weekly Portfolio Holdings collection and summary.)

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