Heading into year end, investors in short-term markets were facing uncertainty regarding the imminent expiration of the Federal Deposit Insurance Corporation (FDIC) unlimited deposit insurance, a looming "fiscal cliff" and the possibility of additional money market reforms. Invesco Global Liquidity's investment professionals discuss the clarity the new year has brought to some of these issues and the possible headwinds facing money market funds going forward.
Invesco begins disclosing daily market-value net asset values (NAVs)
Invesco began disclosing the daily market-value NAVs per share for our US-domiciled prime money market funds on Tuesday, Jan. 29, 2013, on our website.1
This disclosure is consistent with our commitment to transparency and to proactive client communication regarding our money market funds. We believe this disclosure will benefit shareholders and the market more broadly.
This disclosure does not impact or change the management of Invesco's money market funds using amortized cost NAV for all shareholder transactions. It should be viewed as an effort to enhance transparency by providing investors with an additional lens through which to view and evaluate their money market funds.
Expiration of the FDIC's unlimited deposit insurance helps drive asset flows
Absent congressional action, the FDIC's unlimited deposit insurance expired on Dec. 31, 2012, meaning that noninterest-bearing transactional accounts (e.g., demand deposits) are now insured by the FDIC only up to $250,000. We believed there would be some movements of deposits when the unlimited deposit insurance expired but did not know the scope or the speed of such movements.
Heading into year end, money market funds began experiencing strong asset inflows, particularly into institutional government/Treasury money market funds, which were up $41 billion (or 6.6%)2 in December, suggesting some movement of deposits ahead of the expiration and possibly on some fiscal cliff concerns. US money market fund assets edged up during the year, ending 2012 at $2.69 trillion, the highest level of industry assets since June 2011. 2
Invesco Global Liquidity assets under management totaled $73.6 billion as of Dec. 31, 2012, up 1.2% for the year, buoyed by demand for our prime institutional products. For the fourth quarter of 2012, Global Liquidity assets were up 1.3%, as we experienced strong flows into our government and Treasury portfolios.
The fiscal cliff was narrowly averted, but challenging policy calendar remains
The full impact of the fiscal cliff was narrowly averted through a last-minute compromise in the form of the American Taxpayer Relief Act (ATRA) on Jan. 2. The act focused on raising revenues without addressing longer-term spending issues. Nevertheless, the policy calendar for the first half of 2013 remains challenging.
The US Treasury was expected to hit the debt ceiling sometime in February/March. The Senate approved the House proposal to postpone the deadline until May 19, at which point the debt ceiling would not revert to the $16.4 trillion level. In reality, that deadline could be extended even longer through "extraordinary measures" similar to those the US Treasury took after it officially hit the ceiling in December 2012. These measures could extend the limit for anywhere between six and eight weeks, possibly well into July.
Under the Budget Control Act of 2011, which helped avert the first fiscal cliff, $109 billion in uniform-percentage, across-the-board cuts (sequestration) were to take place in 2013 discretionary spending, with the lion's share of the cuts hitting the Department of Defense. ATRA reduced the sequester from $100 to $85 billion and postponed it two months to March 1, 2013.
Congress has not approved a budget to fund the operation of the US government since 2009, instead using a series of continuing resolutions (CRs). The current CR expires on March 27. In the absence of a budget, the government could partially shut down.
Uncertainty remains regarding possible action by rating agencies. The three major rating agencies – Moody's Investor Services (Moody's), Fitch Ratings (Fitch) and Standard & Poor's (S&P) have the US on "negative" outlook. S&P already reduced the US rating from AAA to AA+ following the 2011 debt-ceiling debacle.3 Moody's and Fitch have stated that they expect Congress to raise the ceiling, warning that failure to do so would promote a formal review of the US sovereign ratings. Interestingly, even if the debt ceiling is raised, the rating agencies have not ruled out the possibility of a rating downgrade if there is no credible plan to put US public debt on a sustainable path.
The new year has been marked by lower and more volatile short-term interest rates
The scope and speed at which repurchase agreement (repo) rates fell took many by surprise, despite broad market expectations that rates would experience some downward pressure after the new year. Treasury repo rates averaged 10 basis points4 (bps) in January, down from an average of 20 bps during the fourth quarter of 2012.
This is likely a result of technicals. There has been less repo collateral in the market since the beginning of the year, given the expiration of Operation Twist along with the Federal Reserve's $45 billion per month Treasury purchase program. At the same time, the significant flows into money market funds in December, due in no small part to the expiration of the FDIC's unlimited deposit insurance, has increased demand.
We believe that repo rates could be higher in February due to tax season and the seasonal increase in bill supply, although fiscal-policy uncertainties could rattle markets.
Repayment of the Long-Term Refinancing Operations (LTRO) and the relaxation of Basel III liquidity coverage ratios are positive for commercial paper (CP) issuance. Supply of CP has increased since the beginning of the year, with the level of CP outstanding at its highest since November 2011. Issuance is also moving farther out on the yield curve, with more than 50% of issuance in maturities greater than three months.5
Repayment of the LTROs is also pumping cash into the system, resulting in tighter Libor6 spreads. The spread between the one-month and six-month Libor tightened from 43 bps on Sept. 30, 2012, to 27 bps on Jan. 30, 2013. The Libor curve has flattened with the one-month Libor unchanged at 20 to 21 bps and the six-month Libor falling to 47 bps.7
Comment period for money market reforms proposed by the Financial Stability Oversight Council (FSOC) is still under way
The 60-day comment period for the following recommendations for reforms of US-registered money market funds (MMFs) made by the FSOC was extended from Jan. 18 to Feb. 15:
- Floating NAV – This removes the special exemption that currently allows MMFs to use amortized cost accounting and penny rounding to maintain the $1 stable NAV.
- NAV buffer and minimum balance at risk – MMFs would retain the stable NAV but would require a NAV buffer of up to 1% of assets to absorb the day-to-day fluctuations in the value of the funds' portfolio securities. This would be paired with a requirement that 3% of a shareholder's highest account value be made available for redemption on a 30 day delayed basis.
- NAV Buffer and other measures – MMFs would retain their stable NAV but would be required to have a risk-based NAV buffer of 3% to provide explicit loss-absorption capacity that could be combined with other measures, such as more stringent investment diversification, increased minimum liquidity levels and more robust disclosure.
The extension was meant to allow the public more time to consider the SEC staff report that was issued at the end of November. The SEC study examined the causes of investor redemptions of prime MMFs during the 2008 financial crisis, the efficacy of the 2010 MMF reforms and the likely effect of 2010 reforms on the performance of MMFs during the 2008 financial crisis had they been in place at that time. The study concluded that the 2010 reforms provided added stability to MMFs but would not have provided enough support to prevent further stresses that ultimately required the Treasury's guarantee program.
The Investment Company Institute (ICI) filed an extensive 115-page comment letter on the FSOC proposed recommendations (ici.org/pdf/13_fsoc_mmf_recs.pdf)8, in which it argued that fundamental changes are not necessary for Treasury, government and tax-exempt MMFs and that temporary gates and liquidity fees could serve as effective tools to address redemption pressures in prime MMFs. The ICI also restated its opposition to the floating NAV, minimum balance at risk and NAV buffer recommendations.
At the same time, a new player instrumental to the reform process has been introduced. It was announced on Jan. 24 that President Obama will nominate Mary Jo White, a former federal prosecutor in New York, to head the Securities and Exchange Commission, replacing Mary Schapiro, who retired in November.