US president Donald Trump’s view that the country should accept the “gift” of negative interest rates would be hugely damaging for the nation’s $4.8tn money market funds sector.
Mr Trump believes the US suffers a competitive disadvantage against nations that have more aggressively pursued unconventional monetary policies to support their economies.
So far, his exhortations have failed to influence Jay Powell, the chairman of the Federal Reserve, who is opposed to cutting US interest rates below zero. Even so, derivative markets are already pricing in an unprecedented drop into negative territory for interest rates.
Yields across the US money market fund sector have already tumbled towards zero from about 1.5 per cent at the start of this year. Some investors fear negative rates could spark a disruptive exodus from this vital funding channel for businesses across the US economy.
TIAA-CREF, one of the largest US providers of financial services, warned this month that “returns could go negative” on its money market funds. It has decided to waive fees on money funds until the end of the year to help avoid negative returns for investors. But the company also warned any waived fees would be “subject to possible recovery” in 2021 if yields on its money funds turned positive.
Daniel Wiener, a US financial planner, said TIAA’s disclosure of a fee clawback mechanism was “shocking” and warned other asset managers also held similar contractual rights that were not widely appreciated by retail investors.
“TIAA investors should begin looking for a better alternative,” he said.
That task is becoming more difficult as 360 US money funds with assets of $923bn yielded zero or just 1 basis point, or 0.01 per cent, by mid-May, according to Crane, a data provider. It estimates zero rates will spread to about 40 per cent of US money fund assets.
The growing prevalence of zero yields means fee waivers have also become more common.
Asset managers historically earned wafer thin margins on money funds. So the combination of fee waivers and negative rates presents a toxic threat to the profitability of a sector that accounts for about 14 per cent of the US mutual fund industry’s total assets.
Across the US, disruption caused by the pandemic has led to companies hoarding as much cash as possible. US money fund assets have increased from $3.6tn at the start of the year to $4.8tn.
Peter Crane, founder of the Crane consultancy, suggests uncertainty around the progress of the pandemic has led to a fundamental shift in demand for cash among individuals, companies and institutions.
“No cash war chest is big enough for coronavirus. Everybody has to plan for operating for two months, three months, six months, two years with no revenue coming in, with no cash coming in,” he says.
This shift in demand for cash persuades Mr Crane that negative rates will not lead to dramatic outflows from money market funds.
“I don’t think it’s going out any time soon. [Companies] shouldn’t just have a couple of days of spending money in the kitty. You better have a couple of months. And who knows? Maybe even a couple of years,” he says.
US managers have also tried to draw lessons from the experience of Europe where interest rates dropped below zero in 2015 and have since moved deeper into negative territory.
Alastair Sewell, a senior director at Fitch Ratings, says investors withdrew money from euro money funds just before and after the advent of negative yields.
“Subsequently, a few months later, these funds began seeing inflows again. Investors eventually returned despite the negative yields after finding an inadequate supply of suitable alternatives,” says Mr Sewell.
US money funds, however, have already demonstrated their alarming vulnerability to mass redemptions.
Investors pulled more than $300bn from the sector in 2008 after the Reserve Primary fund “broke the buck” following the implosion of Lehman Brothers. The Fed was forced to intervene with emergency support measures to stem the bleeding and implemented rule changes in 2016 to prevent a repeat of these problems.
But severe difficulties erupted again in March when investors pulled $160bn from prime money market funds that invest in short-term securities including commercial paper and certificates of deposits as the coronavirus outbreak led to a surge in demand for cash.
Large redemption orders from prime money funds forced BNY Mellon and Goldman Sachs to use a new emergency lending facility established by the Fed to swap commercial paper held in prime funds for cash. Bank of New York Mellon swapped $1.2bn in assets from its Dreyfus Cash Management fund as it faced redemption orders for $6bn — equivalent to about half its assets — in a week. Goldman Sachs similarly swapped assets of $1.9bn for cash to meet redemption orders from the Square Money Market and Square Prime Obligations funds on March 17.
With severe stresses continuing to affect financial markets on the following day, the Fed announced the creation of a support facility to help money funds meet redemption requests and to support the flow of credit to the wider economy.
The Fed’s new lending facility for money funds made loans worth just $39.4bn by mid-May but it appears to have achieved its goals in calming the market. Prime funds have since regained all the assets lost during March but some stresses remain.
Northern Trust announced in May that it was closing its Prime Obligations Portfolio fund after intense volatility caused by the coronavirus pandemic led to investor withdrawals of more than $2bn.
Neal Epstein, a senior analyst at Moody’s in New York, says the problems in March resurrected old concerns about prime funds.
“Credit sensitive funds experience outflows and sharp net asset value declines, which spurred [fresh] regulatory intervention in spite of the reforms implemented in 2016 to forestall such circumstances,” says Mr Epstein.
Moody’s downgraded its outlook on the global money market fund industry on March 18 from stable to negative.
The Fed’s facility is due to last until September 30 but can be extended if required, raising the possibility that the central bank could provide long-term support for money funds.
The latest problems are expected to prompt fresh scrutiny from regulators about the role of money funds as part of the shadow banking sector.
“We expect that regulators will once again open the question of prime fund liquidity and [financial market] stability risks,” says Mr Epstein.
Sharp divide: Top economists split on policy
Leading economists are divided over whether the US should adopt negative interest rates.
Kenneth Rogoff, professor of economics and public policy at Harvard University, believes negative rates should be combined with measures to preclude large-scale cash-hoarding by financial companies and pension funds.
This policy combination would prove problematic for money funds but Mr Roggoff is certain it would have wider economic benefits.
“If done correctly, negative rates would operate similarly to normal monetary policy, boosting aggregate demand and raising employment,” he says.
Torsten Slok, chief economist at Deutsche Bank Securities, disagrees. He warns that negative rates will increase the risk of an exodus where money is suddenly withdrawn and “stuffed into mattresses” to avoid the costs of holding cash in an account.
“The bottom line is that a negative Fed funds rate in the US is not the right response to this shock,” says Mr Slok.