Fitch Ratings recently published its "Global Money Market Funds Outlook 2023," which tells us, "Fitch Ratings' 2023 sector outlook for global money market funds (MMFs) is deteriorating, driven by deteriorating outlooks in some of the key banking sectors that MMFs invest in and continued market volatility stemming from the global recessionary backdrop, which could lead to flow volatility, especially in a market stress scenario.... The deteriorating outlooks on UK, US, Canadian and German banks indicate significant uncertainty about the credit quality of this segment, which will have a knock-on effect on money funds as portfolios are concentrated in this sector. Vulnerabilities will be assessed on an issuer basis rather than across a whole sector given the varied rating headroom."
They write, "The gradual stabilisation in the monetary policy stance may see funds start to push out maturities of holdings, albeit selectively, which in turn increases market risk sensitivity. Currently MMFs have low weighted average portfolio maturities (WAMs) as fund managers have reduced these in preparation for rising rates, because low WAMs reduce the risk of potential mark-to-market value declines in portfolio securities."
Fitch's summary says, "High inflation and interest rates, alongside global recessionary pressures, are contributing to mixed expectations for 2023 MMF flow direction and may lead to heightened flow volatility in funds. Continued market volatility driven by the downturn could lead to sizeable outflows in a stressed market. However, investor flight-to-safety during the financial downturn may attract inflows for MMF sector overall, with varied effects depending on fund type."
Director Minyue Wang explains, "Regulators globally have suggested draft proposals or shared opinions on MMF reforms, but no final proposals have been published. We expect an extended lead time before any regulatory changes are implemented in the US and the EU given the length of prior regulatory review cycles, therefore giving investors and MMF providers time to adapt. Fitch expects to review its rating methodology in response to final regulatory proposals, once available, to reflect any potential changes in MMFs' expected risk profiles. Regulatory changes under consideration may lead to outflows from US prime funds or a restructuring of certain products."
She continues, "Fitch expects negative rating action on certain money fund holdings, as the deteriorating outlook on banks indicates uncertainty about the credit quality of this key sector for money funds. As of end-August 2022, banks accounted for about 80% of Fitch-rated prime MMFs. Although the banking sectors is placed on deteriorating outlook in certain countries, the rating impact will vary by issuer. Fitch expects recessions will pressure asset quality, although Fitch believes the major banks have rating headroom."
On the rate environment, they state, "Fitch anticipates the Fed will raise interest rates to 4% by end-2022 and maintain them until early 2024, and believes rate cuts are unlikely until next year. Fitch expects EU policy rates to increase to 2% by end-2022, and that the Bank of England will continue increasing interest rates into 1Q23. MMFs began decreasing WAMs ahead of anticipated interest rate increases in 2022 as lower WAMs limit vulnerability to rising rates and allow funds to maintain competitive yields, with managers reversing previous fee waivers and then passing increased rates to investors. A fund's market risk is reduced with lower WAMs and improves liquidity, which would reduce risk in the current uncertain macro environment."
A separate Fitch Ratings publication, "Local Government Investment Pools: 3Q22," explains, "Fitch Ratings' two local government investment pool (LGIP) indices experienced aggregate asset decreases in the third quarter of 2022 (3Q22). This follows seasonal trends where LGIPs have net outflows in the fall. Combined assets for the Fitch Liquidity LGIP Index and the Fitch Short-Term LGIP Index were $486 billion at the end of 3Q22, representing a decrease of $20 billion qoq and increase of $73 billion yoy."
It comments, "Fitch expects pool managers to continue a low weighted average maturity (WAM), defensive position to maintain competitive yields and navigate the Fed's tightening monetary policy. We expect to see this trend reverse as the Fed slows interest rate increases as indicated in Chair Jerome Powell's speech on Nov. 30, 2022."
The piece says, "Both Fitch indices ended 3Q22 with improved average yield profiles, responding quickly to Fed rate hikes with average net yields of 2.79% for the Liquidity Index and 1.87% for the Short-Term Index. The WAM of the Fitch Liquidity LGIP Index decreased to 24 days, down four days qoq but still higher than '2a-7' money market funds at 13 days. The Fitch Short-Term LGIP Index ended the quarter with a slight increase in duration of 1.07 years, a small increase from 1.04 years at the end of 2Q22."
Finally, this update adds, "The Fitch Liquidity LGIP Index continued to decrease exposures to treasuries and increase exposure to agencies and repos by -3%, 4%, and 1%, respectively. Short-term treasury bill yields have remained below the Fed Funds Rate as demand has outpaced supply. Additional Federal Home Loan Bank issuance in 2Q22 and competitive repo rates presented managers with more attractive opportunities, although increases to these exposures were lower this quarter than the previous one."
