Fidelity on Fed Hike, Spreads
A new white paper from Fidelity Investments, entitled, "Money Markets: Expectations Remain High for December Rate Increase," says that "Federal Reserve guidance supports expectations for a December rate increase." It explains, "While some Fed officials were concerned about the potential for post-election market upheaval, its early November assessment suggested that both inflation and growth were moving in the right direction, which led some to believe the stage was set for a rate increase.... The Federal Open Market Committee's (FOMC's) November statement included the sentence, "Near-term risks to the economic outlook appear roughly balanced." This assessment, along with the improved growth and employment data, further contributed to investor expectations for a December rate hike at the FOMC's next meeting (December 13 and 14). Our base case is that the Fed is likely to increase the fed funds rate 25 basis points (bps) higher in December." Regarding asset shifts since the implementation of market fund reforms, Fidelity's Michael Morin and Kerry Pope write, "October saw the completion of an orderly transition of more than a trillion dollars moving from prime to government money market funds (MMFs). Outflows nearly subsided, and as of November 1, prime MMF assets stood at $372 billion, with $122 institutional and $250 billion retail.... Prime MMFs began to normalize their investments. This can be seen in the weighted average maturities (WAMs) of institutional prime MMFs, which were extended to 19 days from nine during October, and WAMs for retail prime MMFs moved to 30 days. The longer prime WAMs resulted in higher yield differentials relative to government funds. These yield spreads moved from a low of nine basis points in August to 21 bps as of early November and are likely to continue to rise as prime MMFs normalize and gradually extend maturities. With the year-to-date increase of nearly $260 billion in the supply of Treasury bills and Treasury repurchase agreements, government MMFs were able to put increased inflows to work. However, utilization of the Fed's reverse repurchase agreement facility has trended higher throughout the year, suggesting that the increased supply of T-bills and repos did not quite match the inflows to governments MMFs. The effect on money markets resulting from fund regulatory reform has started to diminish. For example, the amount of prime assets maturing is beginning to taper and marginally ease funding conditions. Additionally, increased demand for government-sponsored entity (GSE) agency securities from government MMFs compressed spreads relative to Treasuries to nearly zero. Government MMFs now own over half of the money-market eligible agency coupons and discount notes. The Securities Industry and Financial Markets Association (SIFMA) Index spiked to a multi-year high of 87 bps after more than $100 billion exited municipal MMFs. More recently, the index retreated owing to demand from crossover buyers, including prime MMFs."
