Dreyfus recently hosted a webinar entitled, "Money Market Funds, Rising Rates and Geopolitical Turmoil," which featured CIO John Tobin and Credit Head Keith Lawler discussing rising rates, Treasury funds, bank deposits and other topics. The description explains, "The Dreyfus team discusse[s] how money market funds will be impacted amid rising rates, inflation, and geopolitical friction. Our professionals weighed in on: The structure of money market fund portfolios in the current rate environment, Geopolitical tensions and its potential impact on Federal Reserve policy, [and] How the current credit landscape is evolving." We quote from their webinar below. (Note: Dreyfus' Tobin will also speak on the "Major Money Fund Issues 2022" panel at our upcoming Money Fund Symposium, which takes place June 20-22, in Minneapolis, Minn.)
Asked about the dispersion in yields and high yields on Treasury funds, Tobin tells us, "I think the reason you're seeing a lot of dispersion is one, fund positioning, [and, two] cash flows. [Y]ou saw several funds extend in late February and early March. [This was] still when we were in a world where we thought we were just going to get a series of 25's. [I]n a pretty dramatic twist or, ... hawkish pivot all of a sudden, this idea of going 50 and maybe multiple 50 [bps became the consensus] ... with the backdrop of, hey, we need to hit neutral rates by year end at a minimum. [It was an] unbelievable change of events in a matter of two months. So that's why I think you've seen as much dispersion in performance as we have ever seen."
He continues, "But having said that, I think with this next rate hike, because of the opportunity set in the bill market, there's really not a lot to be done there. We've seen some trading in the last five weeks, but I think this next 50 will tighten things up fairly dramatically."
Tobin comments, "In terms of the Treasury questions, it's really a function of cash flows. Who extended? Who has floaters? We've seen this many times in the past, right? Treasury-only funds don't have a place to hide. Every day you have a subscription or redemption. Let's talk about subscriptions, money coming into the fund. You can't hide in overnights. You basically have to put [money out] on the curve, and they're just forced buyers. Sometimes there's an advantage to that over someone that can hide in often relatively short period of time. Treasury only funds can help."
When asked about how the war in Ukraine impacts issuers, Lawler responds, "I would just start off by ... stating that we have zero direct exposure to any issuers in Russia or Ukraine in terms of holdings and names on the approved list. And I would say that's resoundingly true for the money market industry as a whole. As it relates to indirect exposure in terms of issuers that would have any sort of residual exposure to the region, again, very, very limited. I would classify that as not material."
He says, "So the impact of the war in Ukraine on money market issuers ... is really kind of the second order effects.... I would say now is certainly more challenging in 2022 than the very good conditions that existed in 2021.... You've got elevated inflation, you've got supply chain disruptions, there's been further lockdowns in China, you've got elevated commodity prices and some increased financial market volatility. And all of this is being compounded by central banks."
Lawler continues, "So prime funds, we're buying commercial paper, you know, time deposits, CDs that are issued by banks, or we're doing repo with banks.... So, when you think about some of these ... operating conditions, higher rates are actually benefits for banks. They tend to be asset sensitive. So, we're already starting to see with first quarter earnings a lift in terms of their net interest margins."
He adds, "I would just kind of conclude by saying that both corporates and banks ... went into the pandemic in 2020 with very strong balance sheets. If anything, going into this current environment, they have even stronger balance sheets. So, during the pandemic, we saw a significant buildup of liquidity among corporate and bank issuers. Their capital levels remain very robust. So, there's really ample cushion to kind of navigate in this current environment. And that's kind of facilitated itself in terms of your credit ratings, which I would say remain broadly stable across the board.... But, you know, we’re certainly watching how this plays out."
Tobin summarizes, "The rate that our investors are going to earn on these funds is going to rise dramatically. You just think about ... [with] the magnitude of the Fed hike, ... we're going to basically pop. For investors [over] the last decade, from an absolute rate standpoint, it's been tough sledding. But at least for the next couple of years here and certainly this year, dramatic rate increases in funds will follow very, very quickly."
He also says, "In terms of the backdrop and [credit] environment ... I don't see any inherent risks in that. So, I think `from a safety and sound standpoint, you know, money funds look good. [There's also] a lot of volatility, so, we're seeing a lot of investors shorten up their duration, kind of hiding in cash. [In prior years], we've heard that 'cash is trash,' but that is out the window at least for this year. I think, bottom line, investors can enjoy significantly higher yields."
Finally, Tobin was asked about deposits vs. MMFs. He answers, "That is always the question. In a rising rate environment, what's going to happen to ... assets under management in the money market sector? So, I think the dynamic doesn't change here. If you think about last year, banks were very deposit heavy, a position they didn't want to be in. It was more beneficial for them to shed deposits. And all year last year, we saw that that was a tailwind to the inflows that we experienced."
Tobin explains, "I don't think the posture changes from the standpoint they're still long deposits.... We believe that bank deposit rates ... will move more slowly and they will under-perform money market funds or money market funds more broadly. And we will continue to have that tailwind."
But he adds, "If you look at Q1 for money fund balances, that story doesn't hold.... Government [MMFs] are down, but that's not unusual. If you go back over the last 20 years, there is a calendar effect. We typically bleed assets through Q1. Then what you'll see is in the second half, we'll begin to recoup that. But to answer the question, I believe bank deposit rates will underperform money funds. That will be something that persists all through this year, and we will see more assets by year end and again outperform."
