What's behind the substantial rise in assets of money market vehicles?
While liquidity products such as money market funds and pools invest in banks, it is not a symbiotic relationship. We often compete for clients. Not that we root for them to fail. Their health is critical to the financial system—a fact not lost on the Federal Reserve, U.S. Treasury and FDIC. The latter announced today it briefly seized and then sold troubled First Republic Bank to JP Morgan. While the deposits are secured, and at this time we don't see further contagion in the banking system, it's been a stressful time for customers there and at any regional bank. That's why I’ve always felt cash management should be about more than financial gain. We want people and institutions to thrive, and seeking the best return on their cash, with the least amount of anxiety, can be a large part of that, especially those in or close to retirement.
Indeed, the Fed’s extraordinarily low rates of the last two decades have been particularly hard on savers, so every bit helps. Along with seeking stability of principal, we think part of the appeal of money funds, state pools and similar alternatives is their potential to deliver more “bits” in the form of attractive yields. Interest rates on deposit products, such as a savings account or a money market deposit account (MMDA), generally have not kept up with the rate hikes of this Fed cycle, while money funds across the industry have. Why? Because banks chose to provide administered interest rates based on business calculations. In contrast, liquidity products operate in the marketplace, in which yields on most securities tend to track the rise in Fed rates.
We believe this is at the heart of the recent outflows from bank deposits and inflows to money market vehicles. Institutions have been actively moving around money since the first hike, but individuals and retail clients typically are slower to act. The bank stress initiated by the collapse of Silicon Valley Bank likely caused them to take a closer look at the interest rates on their accounts, especially those greater than the FDIC-insured $250,000. But the trend began about six months ago.
But in any case, we think the relative yield advantage should remain for sometime. The Fed likely will raise rates another 0.25% this week, and hold them higher for longer. Liquidity products likely will stay elevated, too. If this monetary policy cycle were a baseball game, we may just be in the third or fourth inning.
Debt ceiling deal DOA
It's hard to tell if House Speaker Kevin McCarthy’s bill raising the debt ceiling is a step back or forward, but it will do little. He catered to the hardline Republicans by including many spending cuts that Democrats and the Biden administration have essentially ignored. Tax receipts have been decent, probably pushing the Treasury’s X date into July although we expect Secretary Yellen to hold with her June date prediction. The latest political theater does not change our belief that a deal will emerge to either kick the can or raise the limit. We believe both the liquidity industry and Federated Hermes are prepared. A few issues to note in the event of a technical default:
- SEC Rule 2a-7, which governs money funds, does not require a fund to dispose of a Treasury security in technical default. Rather, its Board could—and in all likelihood would—determine it would be best to hold the security given as eventual repayment in full is highly likely.
- Debt issued by a government sponsored enterprise (GSE) is not subject to the statutory debt limit. That’s also the case for non-government securities issued by banks and corporations, such as commercial paper, CDs and tax-exempt money market securities.
- While repurchase agreement transactions (repo) may exhibit volatility, market strains could be addressed by modifying collateral types and margin requirements. The Fed’s Standing Repo Facility and Reverse Repo Facility would be expected to be available for investment for eligible counterparties, including many money funds.
In fitting with our conservative approach, our government money market funds are avoiding Treasuries maturing when we think the X date will land. But we continued to position our portfolios short overall help to capture rate hikes, maintaining Weighted Average Maturities (WAMs) in a 25-35 day range for our government and tax-free money funds and between 20–30 days for our prime money funds.