Fee waivers and duration extension, according to Fitch’s Fund & Asset Manager rating group.
They’re talking, of course, about how European money market funds will react to the ECB’s decision to cut its deposit rate to zero, a fact which should soon push the Euro overnight index average (Eonia) to historical lows of between -15 and +15 bps, putting MMF yields at risk of negativity.
As the team notes on Wednesday, if there’s any precedent it’s probably in what’s happened to US MMF funds already:
In this environment, the decision by some funds to temporarily close to new investments is a prudent one to protect existing investors and will not have any direct impact on ratings. We expect to see a pattern of temporary soft closures continue across the sector. These tend to last until the current portfolio has matured and is reinvested at prevailing rates, at which point new investments no longer pose a risk of dilution for existing investors.
The average maturity of Fitch-rated euro-denominated MMFs currently stands at 45 days and 60% of portfolios mature in less than a month. Experience in the US tells us that fee waivers will be the next development. These will probably come first at banking groups that offer MMFs as part of their multiple services to corporate and institutional customers, while managers that see MMFs primarily as a profit centre are more likely to resist lowering fees if possible.
The current low interest rate environment means investors are paying a particularly high cost to hold highly liquid portfolios. Our research indicates that maintaining a high degree of liquidity can cost around 20bp to 30bp of yield. This high liquidity premium means certain MMF investors are increasingly willing to compromise on liquidity or duration risks in their portfolio, but not on credit risks, leading to increased demand for MMFs with longer investment horizons.
Trying times for money markets funds.
And just to close off, here’s Nomura’s Guy Mandy with his view on the issue (our emphasis):
- Reserves beyond the required reserves are classed as excess reserves and are not remunerated; however, by transferring any excess to the deposit facility banks could previously have avoided a zero rate. Through removing remuneration on the overnight deposit facility the ECB has in effect created excess reserves out of all non-minimum reserves.
The amount of liquidity posted at the deposit facility may drop given the option of instant access through the current account and lack of incentive to hold funds overnight. Increasing aggregate excess reserves could drive Eonia closer to 0% rather than maintain the 8-12bp spread over the deposit rate seen when the deposit rate was 25bp.
- Banks may seek a marginal, non-0%, yield. Although on the margin this may push more liquidity into the interbank market it is unlikely to spur credit extension into the real economy. Given deepening credit concerns in the eurozone banking system any incremental interbank lending will likely be to very high quality institutions. Although of course, in general these institutions are already highly liquid. Without matching demand for the increased supply short-rate compression could result and we could see downward pressure on Eonia and short-rates.
- We are unlikely to see further deposit rate cuts. Central banks that are implementing such rates are doing so partly to avoid harmful appreciation of their currency – a problem the ECB does not face.
- The deposit rate cut, along with the non-standard measures, is leading to serious market distortions. Money market funds are closing subscriptions as negative cash bond rates will undermine the performance of existing fund units. If rates are held at current levels for anything beyond the short term the ability for money market funds to provide funding to banks in their previous capacity will be limited, closing another bank funding source.
- There remains a northern versus southern bank problem: northern banks are putting liquidity back at the ECB while southern banks are taking it. The deposit drop makes these northern banks marginally worse off in aggregate.
- With the compression in the front end of the curve already taking place, we expect bull flattening through 5yr with 10yr following with a slight lag. Ultimately our current target on 10yr Bunds is 1% with the view that this is an intermediate target with the rate expected to trade closer to the lows in JGB yields of 2003 if we are correct in assuming that the ECB remains reactive in its policy response.