Ebb and flow
The month of June—and the year for that matter—has shown the dynamic nature of the liquidity space. While stability is the asset class’ defining feature, its reputation as static has always been unwarranted. Cash products are essential to the fluidity of the markets, especially in times of uncertainty, and crucial to portfolio reallocation, personal finances and capital expenditures in times of growth. All you have to do is look at flows.
As the markets tanked due to fear of Covid-19, assets in government funds skyrocketed for their relative safety. The vast majority of that money came from investors selling positions in stocks, but some came from institutional prime portfolios. As it became clear the pandemic wasn’t ushering in the apocalypse and the Federal Reserve and Congress stepped up, institutional prime funds regained assets, growing nearly 36% from March 31 to June 29. We consider this a vote of confidence from investors who value them for the combination of relative safety and a yield spread above many cash-like alternatives. The London interbank offered rate (Libor) fell slightly over June, but has an attractive spread of around five to 40 basis points over Treasuries depending on the point of the curve.
While the influx is impressive, flows reversed slightly in June. This is not a negative, but further proof of the dynamic aspect of money markets, showing they are part of the collective investing process. A certain amount of ebb and flow in money funds and similar portfolios is part of the process, whether it’s due to investors conserving dry powder for future purchases (witness strong retail sales and the stock market) or businesses withdrawing assets to restart operations. All of this fuels the economic recovery, which is what everyone wants.
Recent Fed action on rates has been helpful. No, not a rise in interest rates, but policymakers increased the overnight and term repo rates by five basis points. We had advocated for a bump in the reverse repo program to raise the floor on overnight rates. But the result has been similar as rates have increased.
Part of the reason for this rise is that the Fed moved the timing of its repo transactions from the morning to the afternoon. It may seem like a case of six of one, half a dozen of the other, but it is quite different. The majority of volume in the repo takes place between 7-9 a.m. While the Fed is offering a higher rate than before, dealers don’t want to wait until 2 p.m. to be funded, so they are offering higher rates in the morning. The Fed wants this—and frankly most of its new programs—to operate as a backstop, not as an active part of the markets. It is another smart move by policymakers.
While the Libor curve fell over the month and the short-term Treasury curve fluctuated but ended essentially where it began, the Sifma Index ticked higher, and municipal money funds have also grown since March. The weighted average maturities of our funds lay in the middle of our target ranges of 35-45 days for government and 40-50 days for prime and municipal.