Here we are today is the day when the new US
Money market reform comes into force it is a good time to get familiar with the
logic behind. Actually, we can already see its impact on the markets anyway…
Few facts
-
During the times of stressed conditions in the
markets the Prime money market funds will be allowed to implement the
redemption fees or temporarily halt redemptions. Very liquid, conservative and
pretty safe funds doing so…? Well, let’s keep reading…
-
Since mid-Aug investors are moving money out of
Prime money market funds to money market funds investing in government papers
only. This action helped to dry up to certain extent the funding liquidity for
non-US issuers of commercial papers and pushed the 3-month and longer yields in
Eurodolar market significantly higher. Actually, Prime funds did so by
shortening the maturities to cater for redemptions.
-
As per new reform, the Prime funds can no longer
guarantee the NAV of $1 and instead, they need to trade at actual NAV. This
will make them less “safe” what was indirectly proved by USD 500 bln that has
already left prime funds and funds keep flowing away.
-
There is one main difference between Prime funds
and Government money market funds – the prime funds have an advantage of buying
commercial papers issued in the US and are not limited to US government papers
only
-
Prime funds are heavily used as a source of USD
liquidity for corporates, non-US banks...etc. as they offer cheaper funding
than other liquidity sources
-
TED spread = 3-month Eurodolar LIBOR minus
3-month US T-bill interest rate
-
In other words it is the difference between how
much banks pay for USD funding and how much is paying US government to fund its
needs
-
Long term average can fluctuate between 30-50
bps, while after Lehman Brother’s collapse TED spread spiked to 457 bps
What to expect?
-
The reform gives the rights to prime money
market funds to protect themselves in case of liquidity squeeze and run to cash
as we saw after Lehman Brother’s collapse
-
The cost of short-term financing in Eurodolar
market (USD deposits outside US) will rise what will impact financing based on
variable rates using a 3-month USD LIBOR as a benchmark
-
As we saw in Aug or around BoJ and FOMC in Sep
and these days due a huge pressure on Deutsche Bank and EU banking system, we
may witness another round of stress closer we get to Oct 14, going to US
elections on Nov 8, Italian referendum on Dec 4 and closer we get to FOMC meeting
on Dec 13-14 (all seen as risk events)
-
Even if the stress caused by upcoming changes
will translate into further rise of TED spread due to worsening liquidity
conditions or due to another risk event, the central banks have enough tools to
contain it all (for example by using existing swap facilities or other tools)
-
With Fed hiking the rates (may be in Dec) the
new reform will not only add few points to TED spread increase but may also have
a negative impact on available liquidity
-
…but meanwhile we still see an ongoing shift to
US T-bills, thus pushing their yields lower within the size restricted pool of
available papers
-
Very negative results can be a lack of liquidity
in commercial papers markets where not only US based corporations and banks get
their short term liquidity
-
Especially, foreign entities are in a delicate
situation as they do not have USD deposits to meet the liquidity shortfalls as for
example US banks do
-
As the world is heavily short of USD from carry
trade we may expect a massive short covering at certain point that may add
additional strength to USD.
The current environment of the excess of liquidity and
money pouring out of the windows will at some point be reversed but we still
wait for the right trigger.
Well, any questions just ask…
Good luck Champs!
Mr Hawk
DISCLAIMER: This material was created for informational
purposes only and represents the Land of Trading team’s view of the past and
current economic and capital market environment. It is not an investment advice
and should not be viewed that way at all, and the creators of this material
cannot be held liable for any potential losses resulting from trading, where
despite this disclaimer someone would consider this material as an investment
advice. All rights reserved ©2016. Contact: landoftradingATgmailDOTcom
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