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W E L L S FA R G O A D VA N TAG E M O N E Y M A R K E T F U N D S
Portfolio Manager Commentary
Overview, strategy, and outlook: As of August 31, 2014
Contributing authors
David D. Sylvester, Head of Money Funds 612-667-5107 | [email protected]
Laurie R. White, Managing Director and
Senior Fund Manager, Taxable Money Funds 612-667-4275 | [email protected]
Michael C. Bird, Senior Fund Manager,
Taxable Money Funds 612-667-6529 | [email protected]
Madeleine M. Gish, Senior Fund Manager,
Taxable Money Funds 415-396-2668 | [email protected]
John R. Kelly, Fund Manager,
Taxable Money Funds 612-667-2045 | [email protected]
James C. Randazzo, Senior Fund Manager,
Municipal Money Markets 704-374-3086 | [email protected]
Michael W. Shinners, Senior Investment Research Analyst
612-667-5523 | [email protected]
Daniel J. Tronstad, Senior Fund Manager,
Taxable Money Funds 612-667-7647 | [email protected]
of this new overnight reverse repurchase agreement
facility (ON RRP) would be to place a floor under interest
rates to improve the effectiveness of the monetary policy
implementation when the FOMC chooses to raise shortterm rates.
Originally, the Fed believed that paying interest to banks
on their excess reserves (IOER) would achieve this goal,
but it failed because the reach of IOER was too limited.
In the end, the federal funds markets proved to be leaky
in that some of the holders of large deposits at the Fed
were ineligible to collect interest on them—notably, the
government-sponsored enterprises (GSEs)—so these entities
continue to invest in the repo and federal funds markets.
Likewise, money market funds and other large money market
participants were ineligible for IOER and market rates traded
consistently below IOER. What was originally envisioned as a
floor under rates in practice became a ceiling.
Tests of the new ON RRP facility, which began on September
23, 2013, indicate it can be effective at providing a floor
under most rates by essentially providing a liquid, risk-free
alternative investment to money market investors who are
ineligible for IOER. While not all GSEs participate and not
all money market participants are eligible, ON RRP seems
to have captured a broad enough base such that general
collateral finance (GCF) and dealer repos have rarely traded
below the rate set for ON RRP.
Federal reverse repo program and GCF repo rates
350
GCF repo rate (left)
Fed RRP rate (left)
Fed RRP amount (right)
0.25
300
250
0.20
Percent
It has now been a year since we first learned of the Federal
Reserve’s (Fed’s) plan to establish an overnight repurchase
agreement (repo) facility that would be open to money
market funds. In the minutes of the July 30–31, 2013,
meeting of the Federal Open Market Committee (FOMC)
released in August 2013, we learned the FOMC had been
briefed “on the potential for establishing a fixed-rate, full
allotment overnight reverse repurchase agreement facility
as an additional tool for managing money market interest
rates.” As we’ve written in the August 2013, September 2013,
January 2014, and April 2014 commentaries, the purpose
0.30
200
0.15
150
0.10
100
0.05
0.00
50
Oct-13
Dec-13
Feb-14
Apr-14
Sources: Bloomberg L.P. and Federal Reserve
Past performance is no guarantee of future results.
Jun-14
Aug-14
0
Billions ($)
Money market overview
In addition to achieving its monetary policy goal of placing
a floor under rates, ON RRP has also given money market
funds some much needed supply, considering other sources
of liquid investments, such as bank deposits and Treasury
bills, continue to contract. This is especially true at monthend and quarter-end, when some banks and dealers pull
back from the repo and time deposit markets in order to
meet their own regulatory hurdles. One astute market
commentator documented the strong correlation between
the amount of bank paper money market funds hold and
the amount the money market funds invest through the ON
RRP facility. As a result, ON RRP has become a substantial
component of many money market funds, especially those
required to invest in government securities, and data show
that, in aggregate, the Fed has become one of the money
market funds’ largest counterparties. Some money market
fund managers have hailed ON RRP as the solution to the
supply woes that have plagued the money markets for the
past half-decade or more, but it now appears the Fed may
not be quite as enthusiastic about ON RRP as these money
market funds.
From the minutes of the FOMC’s June 17–18, 2014, meeting,
we learned some FOMC members expressed a number of
reservations and concerns about “potential unintended
consequences” of the ON RRP facility. According to the
minutes, “most participants expressed concern that in times
of financial stress, the facility’s counterparties could shift
investments toward the facility and away from financial and
nonfinancial corporations, possibly causing disruptions in
funding that could magnify the stress.” In other words, by
providing an indirect alternative to bank deposits that was
unlimited in size (full allotment), ON RRP could exacerbate
a bank run.
Further, “… a number of participants noted a relatively large
ON RRP facility had the potential to expand the Federal
Reserve’s role in financial intermediation and reshape the
financial industry in ways that were difficult to anticipate.”
The minutes also revealed that, “…a number of participants
expressed concern about conducting monetary policy
operations with nontraditional counterparties.” We also
learned that where many money market participants saw
the rate on ON RRP being set at or near IOER, the FOMC saw
a wider spread, “… perhaps near or above the current level
of 20 basis points [bps; 100 bps equals 1.00%]…” would be
more effective.
As market participants were digesting this rejection by
their new BFF, the minutes of the July 29–30, 2014, FOMC
meeting revealed an even more diminished role for ON
RRP. The committee reaffirmed the role of the “… federal
funds rate as the key policy rate …” and its support of “… a
target range of 25 bps for this rate at the time of liftoff and
for some time thereafter.” ON RRP was pushed further back
in line as “participants agreed that adjustments in the IOER
rate would be the primary tool used to move the federal
funds rate … and influence other money market rates.” Gone
was the promise of a permanent new source of unlimited
supply implied by the term full allotment used in the initial
discussion of ON RRP a year ago. As tests revealed that the
facility has been effective in establishing a floor under rates
even with a limit on the allocation to each counterparty, the
FOMC was comfortable now saying, “… the ON RRP facility
should be only as large as needed for effective monetary
policy implementation and should be phased out when it is
no longer needed for that purpose.”
And what happened to the idea that the rates on ON RRP
and IOER would be equal? Fuggedaboutit! Instead, the FOMC
voiced support for linking IOER and ON RRP to the federal
funds rate, with IOER set at the top of the range and ON RRP
set at the bottom—currently a spread of 25 bps.
So why the seemingly quick turnaround in attitude toward
RRP? We think there are several answers to that question.
For one thing, the change is probably not all that sudden
and the discussion stems from an evaluation by the FOMC
of the results of its now year-long test of ON RRP. It would
probably be more disturbing if, after a year of tests, it made
no changes to the original layout of the facility. One of the
downsides to a more transparent process at the Fed is there
can be a lot of cross talk. For those of us used to speaking in
one corporate voice, this can sometimes be confusing.
We must also recognize this is a sea change in the mechanics
of monetary policy and the Fed is a fundamentally
conservative organization that may not handle radical
change all that well. That the necessity of such a dramatic
change stems from the explosion in its own balance sheet,
of its own doing, probably doesn’t alter that basic feature
of the Fed.
The reaffirmation of federal funds as the key policy rate may
stem from governance issues more than anything else. While
the FOMC is empowered to set targets for federal funds and
the rate for ON RRP, the rate on IOER is set by the Board of
Governors under Regulation D. Turning to these new rates
as key indicators would mean a transfer of authority in one
direction or another that is likely not palatable or possible.
It may be much easier to retain federal funds targeting
by the FOMC and then base IOER and ON RRP on federal
funds. The Fed is also probably looking ahead to a period
of normalization when there is a natural short base for
2
reserves among banks. If and when that day ever comes,
it will be important to have preserved a method of trading
those reserves.
The idea of ON RRP as a potential facilitator of a bank run
probably looms larger in the minds of the FOMC members
than in those of money market participants. Low probability,
high negative outcome events are of utmost interest to
the Fed, and because unlimited size does not appear to be
necessary in order to establish a floor under money market
rates, there is no need to even open the possibility—better
to limit the size now than to scramble to find the right
formula and do so in the midst of a crisis.
The idea that the Fed is uncomfortable with taking on a role
as financial intermediary should not be discounted. These
are, after all, the same folks who sponsored the transparently
titled “Workshop on the Risks of Wholesale Funding” 1 at the
New York Fed this past month, and several Fed presidents
have consistently been outspoken critics of money market
funds during the recent debate on regulatory change. So
the idea of actually transacting with money market funds
and becoming an integral part of the woefully misnamed
shadow banking system is likely an anathema to some of the
FOMC members.
that it is—then we will likely see a continuation of the ON
RRP facility beyond the end of the test period. Regulatory
changes mandating holdings of high-quality liquid
assets by banks, money market funds, derivative markets
participants, and others, along with a continued strong
investor preference for liquidity, point to a strong demand
for overnight investments. Prior to the test of the ON RRP, we
did see repo rates dip into negative territory on occasion, so
it would appear that ON RRP fixes that particular problem.
We may see other high-quality liquid assets, such as Treasury
bills, still trade well below the federal funds range, but that
does not appear to be an impediment to the implementation
of monetary policy.
So where does this leave us?
So, we are put on notice that the Fed is adopting ON RRP
with reservations and will not keep the program in place a
moment longer than is absolutely necessary. But we are not
as optimistic as the Fed about its ability to shrink its balance
sheet, which now stands at an astounding $4.5 trillion and
consists mostly of U.S. Treasury, agency, and mortgagebacked securities acquired in the implementation of its
quantitative easing programs. So we would expect, absent a
better idea, ON RRP will be a feature through this entire next
cycle of tightening of monetary policy and up to the next
time the Fed chooses to ease—or, in money market lives,
well over a thousand overnight maturity rolls.
If the Fed is still interested in placing a reasonably firm
floor under money market rates—and every indication is
Who knows? By the time it’s all over we may all become
BFFs yet!
Rates for sample investment instruments
Current month-end % (August 2014)
Sector
1 day
1 week
1 month
2 month
3 month
6 month
12 month
U.S. Treasury repurchase agreements (repos)
0.05
0.05
0.08
–
0.09
–
–
Fed reverse repo rate
0.05
–
–
–
–
–
–
–
0.01
–
0.02
0.03
0.08
Agency discount notes
0.03
0.02
0.04
0.05
0.05
0.07
0.16
LIBOR
0.09
0.12
0.16
0.20
0.23
0.33
0.57
Asset-backed commercial paper—First Tier
0.13
0.14
0.15
0.18
0.21
–
–
Dealer commercial paper—First Tier
0.12
0.15
0.15
0.16
0.18
0.27
–
Municipals—First Tier
0.04
0.05
0.06
0.07
0.07
0.08
0.12
U.S. Treasury bills
–
Sources: Bloomberg L.P. and Wells Capital Management
Past performance is no guarantee of future results.
3
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1. Federal Reserve Bank of New York; Workshop on the Risks of Wholesale Funding; August 13, 2014
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