Tighter than you think

Continuing our musical references, this blog’s title is in part an homage to the recent Paralympics and GB’s outstanding success excellently covered by Channel 4, accompanied by Public Enemy’s ‘Harder Than You Think’.
It is also a reference to the US interest rate decision last week that voted to leave the Fed Funds rate unchanged although the three dissentions bring a rate rise in December, post the Presidential Election, more likely. The media frenzy on will they (Federal Reserve), won’t they, leaves some interesting developments beneath the radar.
As asset managers it is part of our duties to dig for these under-covered yet relevant developments as they often have an impact on financial markets. Things that skip the media’s attention or they misrepresent are usually the reason behind our blogs. One such development is taking shape in the US$ Libor market – and I’m not talking about ‘rigging’ either.
On October 14th this year, US money fund reform comes into effect.  In 2014, the Securities and Exchange Commission (SEC) issued new rules for the management of money market funds to enhance their stability and resilience.
This followed the events of 2008 when some prime money market funds run by financial institutions ‘broke the buck’ – in other words, let the net asset value (NAV) of their money market funds drop below par or $1.00. This was perceived to be an event that wouldn’t happen.
So eight years on the impact of that event is materialising. To ensure the buck isn’t broken again, the liability is being taken on by a need to invest in short term government securities and the new restrictions too onerous for non-government institutions to offer the ‘Prime’ money market products they used to.
The following chart published the day before the Fed’s rate decision last week is a good illustration of the drain from ‘Prime’ money market funds and the subsequent increase into government money market funds. Since the 2014 SEC announcement, ‘Prime’ funds’ assets have halved which in money terms means US$750 billion have left and gone to the government equivalents. How much will follow in the remaining days to October 14th?
This matters because corporate CFO’s and treasurers have used this previously cheap and readily accessible source of funding to meet payrolls, operating and other expenditures. If the cost of that source has risen from around 0.15% to 0.55% as measured by US$ Libor (the red line in the chart), monetary policy has already tightened for companies. While large corporates can fund themselves for longer periods in the bond markets, many cannot.
Whether this development was an influence in the Fed’s deliberations, we don’t know but it could well have been. US monetary policy is already tighter than you think.

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