The Financial Times asks "What happens when money market funds close?" in a recent issue of a newsletter called "Unhedged." They discuss "Money market fund closures," writing, "A handful of cash managers including Vanguard and Capital Group are planning to shut some of their US money market funds, or convert them to different structures, instead of paying for upgrades to comply with new rules due later this year. So, what happens to the short-dated debt held by these funds? Will it be scooped up by other buyers? Is there enough demand elsewhere? The short answer appears to be: yes, probably. But it's a situation we'll be monitoring closely in the next few months." (Note: With less than 3 weeks to go until our big Money Fund Symposium show, we're still taking registrations. We hope to see you in Pittsburgh June 12-14!)
The article explains, "The Securities and Exchange Commission will implement regulations in early October that target prime institutional money market funds. Unlike government funds, these can hold short-dated company and bank debt. The new rules mean that a liquidity fee will be imposed on departures whenever net redemptions exceed 5 percent of a fund's total net assets in a single day. The idea, in essence, is that such charges will help protect investors by preventing large-scale exits from prime institutional vehicles like those seen at the start of the Covid crisis in 2020, when some managers had to sell assets at discounts to handle outflows." [Crane Data Note: The rule changes also require prices to move substantially for any fee to be imposed.]
The FT piece tells us, "But as we wrote last month, a few cash managers have said they'll either close funds or convert them to another type of vehicle before the SEC rules come into play. Vanguard and Capital Group are two such converters, both switching multibillion-dollar internal funds used by their portfolio managers for cash management from prime to government assets. Based on overall announced closures or conversions so far, US institutional prime money market fund assets are on course to shrink by more than a third this year, or roughly $220bn out of a total market size of $625bn, according to Crane Data."
They ask, "So, what are the implications for some of the assets these funds own -- namely US commercial paper and US banks' certificates of deposit? First off, the buyer base for these instruments has diversified significantly since the last set of US money market reforms in 2016, which also prompted a wave of conversions. One big change is that prime retail funds -- the domain of private investors -- have grown considerably, and are now larger overall than their institutional counterparts. Crucially, prime retail money market funds will not be affected by October's rules. That should help to plug any potential demand gaps."
They quote, "Robert Crowe, Citi's head of money markets origination, predicts that borrowing premiums (aka spreads) for commercial paper may widen a little in the next few months. But this could entice other buyers into the space, attracted by cheaper pricing to move opportunistically.... '[W]e're pretty confident that the commercial paper market will be robust for some time', says Citi's Adam Lollos, head of short-term credit trading and origination. 'Especially as we have higher interest rates that seem like they're going to hang around for some time.'"
In other news, the latest "Minutes of the Federal Open Market Committee April 30–May 1, 2024" tell us, "The policy rate path derived from futures prices implied fewer than two 25 basis point rate cuts by year-end. The modal path based on options prices was quite flat, suggesting at most one such rate cut in 2024. The median of the modal paths of the federal funds rate obtained from the Open Market Desk's Survey of Primary Dealers and Survey of Market Participants also indicated fewer cuts this year than previously thought. Respondents' baseline expectations for the timing of the first rate cut -- which had been concentrated around June in the March surveys -- shifted out significantly and became more diffuse."
They continue, "The manager then turned to money markets and Desk operations. Unsecured overnight rates were stable over the intermeeting period. In secured funding markets, rates on overnight repurchase agreements firmed somewhat over the March quarter-end reporting date, in line with recent history. Market participants generally reported that the return of somewhat higher rates around reporting dates had not been associated with any issues in market functioning. Despite the ongoing balance sheet runoff, take-up at the overnight reverse repurchase agreement (ON RRP) facility was largely steady over the period, likely reflecting fewer attractive private-market alternatives for money market funds (MMFs) amid a recent reduction in Treasury bills outstanding as well as a decrease in MMFs' weighted average maturities. ON RRP usage was also likely supported by typical month-end dynamics. The staff and respondents to the Desk's Survey of Primary Dealers expected ON RRP take-up to decline in coming months."
The Minutes say, "Over the intermeeting period, the market-implied path for the federal funds rate through 2024 increased markedly, and federal funds futures rates suggested that market participants were placing lower odds on significant policy easing in 2024 than they did just before the March FOMC meeting. Consistent with the rise in the implied policy path, nominal Treasury yields at all maturities also rose substantially as investors appeared to reassess the persistence of inflation and the implications for monetary policy. Market-based measures of interest rate uncertainty remained elevated by historical standards."
They also state, "Conditions in U.S. short-term funding markets remained stable over the intermeeting period, with typical dynamics observed surrounding quarter-end. Usage of the ON RRP facility leveled off during the first few weeks of the period, primarily reflecting MMFs slowing their re-allocation into Treasury bills."
The Minutes continue, "Funding risks were also characterized as notable. Assets in prime MMFs and other cash management vehicles continued to grow steadily. The staff assessed that the financial stability risks associated with the fast-growing private credit sector were limited so far because of the modest leverage used by private debt funds and business development companies and the limited maturity mismatch present in their funding vehicles. However, the staff also noted the growing connections between private credit and the banking sector, the growth of some forms of private credit, and the fact that the private credit market has yet to experience a severe credit downturn."
Finally, the Fed comments, "In their consideration of monetary policy at this meeting, all participants judged that, in light of current economic conditions and their implications for the outlook for employment and inflation, as well as the balance of risks, it was appropriate to maintain the target range for the federal funds rate at 5 1/4 to 5 1/2 percent. Participant assessed that maintaining the current target range for the federal funds rate at this meeting was supported by intermeeting data indicating continued solid economic growth and a lack of further progress toward the Committee's 2 percent inflation objective in recent months."
