The European Central Bank’s decision to cut its deposit rate below zero is unlikely to cause a stampede out of eurozone money market funds, with some investors are expecting yields to stay positive in the near term.
The European Central Bank’s decision to cut its deposit rate below zero is unlikely to cause a stampede out of eurozone money market funds, with some investors expecting yields to stay positive in the near term.
Many in the market had been concerned that the unprecedented rate cuts would squeeze short-term interest rates to zero or below. That could wipe out already dwindling returns for money market funds – an important source of short-term funding for banks, companies and investors.
The funds had been warming to the eurozone as its sovereign debt crisis eased and banks started borrowing more from the market. US money market funds hold eurozone assets of €350bn.
But investors were mindful of events in 2012, when the ECB cut its overnight deposit rate to 0%, driving short-term interest rates into negative territory.
Many say the situation is different this time. Market moves in 2012 were exacerbated by a worsening debt crisis that has since eased.
While the amount of surplus cash in the banking system is set to rise later in the year when the ECB starts pumping out its new four-year loans, it will still be way below the peaks hit in 2012 of around 800bn euros.
Banks are repaying crisis loans and there are doubts as to how much appetite banks will have for the new conditional loans, especially as they still face stringent stress tests before the end of the year.
Even though the overnight bank-to-bank Eonia rate has fallen to an all-time low of 0.04% and may turn negative in the near term as excess liquidity rises, many in the market expect short-term rates, particularly in maturities over one month, to stay positive.
“We still think that money market rates will stay positive but at low levels. The ECB also made strong suggestions that for all practical purposes we are at the lower bound for rates. The market has certainly taken notice of that,” said Jim Fuell, European head of Global Liquidity at JPMorgan.
“At this time, we don’t expect the yield on JPMorgan Money Market Fund to turn negative in the near term and all of our euro funds remain open to business as normal. We will continue to monitor market conditions closely.” According to Fitch Ratings, the risk that money market fund yields will turn negative was lower than it was 18 months ago at the height of the eurozone debt crisis, which saw a flight to quality to top-rated securities from the periphery.
Many of these funds had been preparing over the past year for the ECB’s move and some have been extending maturity or moving down the credit quality spectrum. “MMFs are likely to continue to look for yield-picking investment opportunities with longer-dated assets, taking advantage of the steeper yield curves since end-2013,” Fitch Ratings said in a recent note.
It noted that they had increased their allocation to assets with maturity of more than three months during the first six months of the year. The move was most pronounced in May, because most funds anticipated the ECB rate cut and their portfolios’ average maturity now extended to 58 days on average at the end of last month, 10 days longer than at the beginning of the year.
Deborah Cunningham, chief investment officer of Pittsburgh-based Federated Investors’ money markets, said the firm’s euro fund had an average maturity of 57 days, 13 days longer than its US dollar fund.
She also said an improvement in the credit ratings of peripheral euro zone issuers who were all but shut out of the market two years ago was also offering investors more choice of short-term debt to invest in.
For Andrew Wilson, chief executive officer for EMEA at Goldman Sachs Asset Management, what happens to money market rates will depend on the effectiveness of the ECB’s new long-term cheap loans and its decision to suspend the sterilisation of sovereign bonds it bought at the height of the crisis.
“We expect to see a bit of that money move further out along the curve, but it will depend on how effective those other measures are.”
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