Money Market Memo: Enough, already
Here we are again, on the edge of a fiscal cliff that could cause the U.S. to default on its obligations, and the news out of Washington doesn’t seem to be getting any better nor do the two sides seem any closer. Of course, we have been here before, in the summer of 2011 and at the end of last year, and in both cases, a last-minute deal was cut, the can was kicked and everyone breathed a sigh of relief.
We feel fairly confident in a similar outcome this time around, with the debt ceiling being raised before the end of Oct. 17, when the Treasury exhausts the extraordinary measures it has at its disposal to meet the financial obligations of the federal government. As it was before, however, getting from here to there is likely to be messy for the markets and the public at large.
No matter how unlikely that an actual default will occur, this latest episode again has begun to raise some market speculation as to what a technical default might mean to money market funds that hold Treasury securities, so we wanted to revisit some of the basic questions surrounding this issue.
First, Securities and Exchange Commission Rule 2a-7, which governs money market funds, does not require that a fund dispose of a security that is in default. Rather, it permits the fund to continue to hold such a security, provided that the board of directors of the fund has determined that disposal of the security would not be in the best interests of the fund. Rule 2a-7 indicates that such determination may take into account, among other factors, market conditions that could affect the orderly disposition of the security. Given the expectation that any potential technical default on Treasury securities would be very short-lived, it is possible that a fund's board could make the determination to continue to hold the security.
Second, although all short-term securities might exhibit some degree of volatility during this time, we would expect the market reaction to remain substantially below the threshold which might exert significant downward pressure on the net asset values (NAVs) of money market funds. All things being equal, it would take an instantaneous increase in rates on short-term securities of approximately 300 basis points before the NAV of a money market fund with a 60-day average maturity would be in danger of breaking a buck. Such an extreme market overreaction is hard to imagine.
Finally, Federated’s money market funds are absolutely committed to maintaining liquidity to meet the needs of their shareholders in the event that an increase in the debt ceiling is delayed. Rule 2a-7 already requires money market funds to maintain stringent minimum liquidity buffers for daily and weekly liquidity needs. Federated would expect to continuously evaluate the potential liquidity needs of its money market funds and augment their existing liquidity position with greater daily or weekly positions, cash balances or alternate liquidity sources should it appear necessary if the conflict continues.
We wouldn’t be surprised if the players on both sides in Washington take us right to the edge of yet another cliff in an effort to play this out for short-term political advantage, but we also think that someone will blink at the last minute—no one wins when systemic risk in the global financial markets is unleashed. While we believe that political brinkmanship will give way to the hard realities that a failure to raise the debt ceiling would pose to the United States, we are diligently working to prevent this showdown from undermining our primary goal: providing clients with a stable source of cash management.