Fidelity on Rates, Spreads, Segmenting
Fidelity Investments released its latest "Money Markets" update, entitled, "Market Correctly Anticipated Fed Rate Move last week. Written by Michael Morin and Kerry Pope, it tells us, "At the end of November, the market's expectations were finally starting to reflect those of the Fed's forward guidance. Fed funds futures were pricing in a 100% probability of a 25 basis point (bp) December hike.... Traders were starting to price in two rate hikes in 2017, beginning as early as June. Fed minutes from an early November meeting were relatively dovish compared to statements from Fed governors in the post-election environment. At its December meeting, the FOMC met trader expectations and increased the target range for the fed funds rate by 25 basis points. Another key topic under discussion post-election is the new administration's ability to replace up to five members of the FOMC (out of 12 in total, though only 10 are serving now with two board seats empty). It's unclear which route the administration will choose to go, but the possibility of big changes with an impact on policy is real." The piece also says, "Money market funds were well positioned for a potential December rate hike," explaining, "Prime money market funds (MMFs) have maintained fairly short weighted-average maturities (WAMs) to help minimize variable-net-asset-value (VNAV) volatility and to address potential year-end outflows. The average institutional prime MMF WAM ended the month at 19 days, while retail prime MMFs remained at 29 days. With WAMs so short, prime MMFs have experienced little VNAV volatility and are positioned to reset quickly to benefit from a December rate hike. (Prime MMF VNAVs are currently averaging a price above par at $1.0002.) Reform-related flows have largely stabilized with prime MMF assets under management up about $3 billion in November to $374 billion.... With spreads widening between prime and government MMFs, assets in prime MMFs could increase in the year ahead. Prior to transitioning back into prime MMFs, we anticipate that institutional investors will seek to segment cash holdings, review VNAV operational and accounting procedures, and socialize VNAV tax implications. Additionally, institutional investors may review the size of their targeted prime MMF balances to ensure compliance with established concentration limits, as nearly all prime MMFs are considerably smaller post reform. As market rates become more attractive than bank administered rates, money market industry assets could break out of the $2.6 to $2.7 trillion range. Government MMFs have absorbed the influx of assets in an orderly manner, helped by increases in Treasury bill and tri-party repurchase agreements. However, the Fed's Reverse Repurchase Agreement (RRP) facility may be heavily utilized around year-end as market sources of supply become constrained.... As a result, several government MMFs may max out their $30 billion counterparty limit, which would force them to consider lower-yielding alternatives."
