In a global financial environment dominated by negative interestrates and central banks signaling even more accommodative policies,the U.S. money-market industry is thriving.

Normally seen as a place to park cash during times ofuncertainty, taxable funds have seen roughly $136 billion ofinflows this year, even with U.S. equity markets surging and bondsposting positive returns, Investment Company Institute data show.Overall assets have swelled to more than $3 trillion, the highestlevel since the financial crisis.

Demand is being aided in part by attractive U.S. short-termyields relative to bank deposits—helped by three years of FederalReserve interest-rate hikes, an inverted yield curve, and volatility infinancial markets. Total assets in government money funds are at arecord high, and investments in prime funds are the most sinceSeptember 2016, before industry reforms went into effect.

While the specter of Fed rate cuts is not perceived as an imminentthreat, it will be a topic among attendees at the Crane's Money Fund Symposium in Bostonbeginning Monday. Other issues likely to come up include the dropin yields and narrowing spread between government and primemoney-market funds, as well as the post-reform growth of the marketfor repurchase agreements and popularity of sponsored repo.

“Money fund yields are still above 2 percent, whether it'sgovernment or prime,” said Pia McCusker, the Boston-based globalhead of cash management at State Street Global Advisors Trust Co.“That's still attractive to investors today. If people are lookingfor a safe haven, cash is still a great place.”

The yield on two-year Treasuries have dropped almost 74 basispoints, to 1.75%, this year.

The Fed Effects

Now that the Fed has scrapped the use of “patient” whendescribing its approach to monetary policy changes, derivativesmarkets are pricing in more than 25 basis points of easing at thenext Federal Open Market Committee (FOMC) meeting in July. Yet fundmanagers are nonplussed, given that money rates are still moreattractive than bank deposits. Historically, money funds tend tosee outflows one to two years after the Fed cut rates, according toAlex Roever, head of U.S. rates strategy at JPMorgan Chase &Co.

After a series of risk-off events in 2007 and 2008 that pushedinvestors into money funds, the Fed cut interest rates to zero,which crushed money-market yields. Investors pulled cash from moneyfunds in search of higher-yielding assets. “It wasn't the fact thatthey had to cut rates,” Roever said. “It's that the overall levelof rates got so low in that scenario.”

Another issue that could arise is whether the Fed decides tointroduce a tool to keep money-market rates under more control.Rates for repurchase agreements—a key component of short-termfunding markets—have recently shown a tendency to spike aroundmonth-end, which has helped to pull the fed funds rate higher. FedChairman Jerome Powell said at his post-meeting press conferencelast month that the central bank will, at a futuremeeting, look at the idea of a so-called standing repofacility.

Impact of Lower Yields

Even as money funds remain attractive investment vehicles, thedrop in yields will be a topic of discussion. After peaking ataround 30 to 35 basis points in December, the spread between primefunds—which invest primarily in commercial paper, certificates ordeposits and time deposits—and government funds has collapsed toaround 20 basis points, according to State Street's McCusker.

Part of that is related to commercial paper issuance and wherefinancial institutions are choosing to issue. So far this year,there has been an average 21 issues of AA rated CP longer than 81days on a typical day, Fed data show. That isdown from an average of 28 issues during the same period in 2018.This dearth of supply “bleeds through to LIBOR settings being lowerand overall yield being lower on prime funds,” Roever said.

Given the growth in government money fund assets after the 2016reforms were enacted, the repo market has expanded to keep up withthe increased demand. Dealer repo with money-market funds has risento $1.2 trillion as of the end of May, Office of Financial Research(OFR) data show. That'sbecause of the growth in sponsored repo, which are transactionswhere dealers sponsor non-dealer counterparties onto Fixed IncomeClearing Corporation's (FICC's) cleared repo platform. Last month,money fund cash invested in cleared repo jumped to a record $154billion, according to OFR, up from about $5 billion in June 2017when funds first started participating.

Barclays Plc strategist Joseph Abate expects sponsored repovolumes to grow, though “it's difficult to project how popular theprogram will become,” he wrote in a note published June 19. “Howmuch single counterparty exposure to the FICC does a money fundwish to have? 25%, 50%, or more?”

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