State Street Global Advisors hosted a "State of the Markets 2017" webinar yesterday entitled, "Divergence & Opportunity in Global Cash Markets." Hosted by Portfolio Strategist Will Goldthwait, it featured Global Head Cash Management Pia McCusker and European Head of Cash Distribution Gunjan Chauhan, and featured rate hikes, the US debt ceiling and money fund reform in Europe. Goldthwait explains, "We hope you find today's discussion informative and useful. Today we are going to discuss three topics -- economic data and market developments, money market reform in Europe, and money market reform in the US." We excerpt many of the highlights below.
McCusker says, "With regards to rate hikes ... the Fed has been encouraged by the jobs data here in the US. [F]or the past 5 years the country has added, on average over 200k jobs per month, but we all know that and this has not been a concern. I think the key piece to the puzzle has been inflation.... These are all welcome signals for the Fed and should allow them to slowly move rates higher in 2017. In addition, politics aside, we have an administration that has promised a trifecta with of infrastructure spending and stimulus, tax cuts, and deregulations. These actions should be bearish for bonds and should continue to support the Fed gradually moving short term interest rates higher, to cool what might be an overheating economy. Nevertheless, we still remain cautious ... recall that at the end of 2015, the Fed was setting up for 4 interest rate hikes for 2016, only to achieve one."
On the debt ceiling, she comments, "Ultimately, under the language of the debt limit suspension, the Treasury has to get its cash balances down to $23B by March 15th. To date, the Treasury has cut bill issuance significantly slower than expected.... Either way, we expect to see issuance ramp back up immediately as soon as they meet the cash target on the date.... The Treasury will utilize their extraordinary measures to gain borrowing authority in the short term period. How long they can issue before exhausting their extraordinary measures will depend on the strength of the tax receipts in April. Most market participants are anticipating not hitting a drop-dead default day until late September or early October."
McCusker adds, "It is also possible that since the new Treasury Secretary Mnuchin has been confirmed, he can convince Congress to pass either a new debt limit or a new suspension, avoiding the whole mess totally. This is not the current base-case scenario but has to be assigned a non-zero probability."
Goldthwait then asked about European MMF reforms. SSGA's Chauhan responded, "Let's frame the discussion with some stats. First, we know VNAV funds tend to be concentrated in France ... that's a market that is a little over 300 billion. But the rules regarding that market are going to stay in place, so let's assume this remains relatively as is. So that turns our attention on to the CNAV funds, of which there is a little more than $650 billion. Two-thirds of those assets are in US dollars. `Given the behavior of what US prime clients last year actually experienced, we will be keen to understand how CNAV dollar clients respond to reform. That leaves approximately 90 billion sterling assets and approximately 170 billion in Euro CNAV balances."
She continues, "Now let's consider the potential rule changes. EU money fund reform divides MMFs into four broad categories: 1) Public Debt C-NAV funds, maintaining a constant share price to 2 decimal places, and will be largely made up of government debt; 2) Low Volatility NAV funds (LVNAV)– investing in prime assets, seeking to retain constant share price with 2 decimal places; 3) Short-Term VNAV – Features less conservative diversification and liquidity requirements; and, 4) Standard VNAV – Identical to ST VNAV funds, with longer maturity and asset life constraints. CNAV and LVNAV will be subject to liquidity gates and redemption fees however, VNAV funds will not.... It's the exact opposite of what happened in the states to some extent."
Chauhan asks, "So how will clients react? Those clients that are in VNAV funds now should carry on business as usual, right? Well we will see. Whilst there is a high level view on what clients are possibly signaling, I feel it is too early to state for certain. The devil will be in the details around how important gates and fees will be versus a V-NAV construct, albeit in government or LVNAV structures. As implementation draws closer, we would expect to see clients begin to move assets appropriately into their chosen go-forward strategies, and we are spending a great deal of time ensuring we are positioned to support clients through this decision making process at SSGA."
Goldthwait responded to a Crane Data question on the timing of the European changes after the call, explaining, "The rule changes have been announced and are in the process of being translated into the various languages. Then legal will review, and it's hoped to have it published by the end of March 2017. From that date, new products will have 12 months to become compliant with the rule changes and existing products will have 18 months. So that puts us at end of Q3 or beginning of Q4 2018 ... [but] still no firm date."
He then asked McCusker about money returning to Prime funds. She answered, "It's interesting and a little bit puzzling. We have had over 100 face to face clients meetings so far this year (2017) and many of those clients are talking about moving back to prime. However, it has been a pretty gradual process. Thus far we have only seen about 16 billion move back into prime. `We have seen the spread between prime and government funds, on average, move to 35 basis points, with some fund spreads being as wide as 40 basis points."
McCusker continues, "We have also been monitoring NAVs and liquidity levels.... NAVs on the 5 largest prime MMFs [have] been tracking in a tight range, never moving more than 2 basis points in a single day and often moving back to the previous point the next day or a few days later. The other aspect we have been keeping a close eye on is liquidity.... [It] has been, as expected, hovering right around 50%.... These are all positive attributes for investors, so the opportunity is there. Whether it's a prime fund or an ultra-short term bond fund, the market is willing to pay a larger premium than it has prior to reform."
She says, "Prior to reform over the course of 10 years prime funds on average were yielding approximately 10-15 basis points above government funds. Granted much has changed around the structure of a prime fund, but for many investors a yield pickup of 30-40 basis points is significant to their budget. Ultra-short term bond funds also provide an interesting opportunity. We have seen reasonable growth in the sector of ultra-shorts. And those funds we manage here at SSGA have provided good relative value for our clients."
Goldthwait adds, "I was just visiting with three clients yesterday and they all talked about moving back into prime for some portion of their cash, but had no time line in mind. All three were interested in seeing the flows before they made any adjustments to their allocations."
Finally, they discuss negative returns in Europe. Chauhan states, "In the EUR market, much like in the CHF market negative yield have become a new reality and one that cash investors have come to accept as the price of holding liquidity. There are opportunities to mitigate, but at the compromise of either credit quality or additional duration. Ultimately it comes down to why clients are holding liquidity and remembering a cash investor's objective. We understand cash at SSGA, and we appreciate that negative yields are absolutely painful. But we also take on board how incrementally important holding liquidity is for our clients.... [T]herefore we see it as our role to protect that capital, liquidity and access to cash for our clients."
