Month in Cash: About that elephant in the room


Before we discuss what’s happening—and more accurately, what isn’t—on the rate front, let’s get the elephant in the room out of the way. As most if not all of you know by now, the Securities and Exchange Commission has adopted new rules for money-market funds, the most notable of which will require net asset values (NAVs) to fluctuate on institutional prime and institutional municipal money-market funds—Treasury, government and retail funds are exempt. First, it’s important to understand this change won’t take effect for two years. But I do expect our industry to begin to react sooner than that with new options and products for clients.

Might the SEC-mandated changes impact money-market rates? Potentially. Let’s say some institutions opt to move into products other than money funds, such as bank CDs. That could have the effect of lowering money fund demand. Maybe the economy continues to improve, driving up the use of corporate finance and commercial paper. That could have the effect of boosting the supply of potential money-fund portfolio securities. Together, less demand/more supply could conspire to push up money-fund security yields. But if that were to happen, the higher yields very well could lure back investors who left the market, raising demand again and driving down yields.

There are always unintended consequences
In other words, supply-and-demand factors and market dynamics will determine what ultimately happens. But again, it’s a two-year implementation time for the floating NAV on a limited set of funds, and we don’t think rates are going to start to rise for fundamental reasons until the 2015 time frame, so all of this is down-the-road conjecture. That said, another big plus from our point of view was the SEC’s decision to retain the $1 per-share NAV using amortized-cost pricing for Treasury, government and retail funds. The beauty of this highly mechanized accounting method is it effectively allows for instantaneous pricing on transactions—a client can send us a request to redeem a portion of their funds at 10:30 in the morning and can have their money by 11.

Hourly, even same-day pricing is more problematic and less certain with a fluctuating NAV. Unlike stocks or bonds, where buyers and sellers continuously set the price for a security every time it trades, there really isn’t a market for most money-fund portfolio securities. People don’t trade commercial paper, CDs and many other similar short-term instruments. This means market prices for the underlying securities in a fund essentially have to be created by an approved pricing agency with each trade, using assumptions at the specific time of the trade that may not hold up over time. Just how this will work has yet to be determined—this is a major reason the rules don’t take effect for another two years. But suffice to say, it likely will be much more complicated and costly than the current amortized-cost method. I don’t mean to sound critical—it is what it is—but the fact is the change to a floating NAV is not an easy one. There are always unintended consequences whenever there are major rule changes.

Signs of a rate uptick … down the road
As for the current money-market environment, there was little movement along the cash-yield curve over the past month—rates remained stubbornly low, save for a slight steepening on longer end of the curve that corresponds both to the end of quantitative easing and the initial moves up in the target funds rate. The consensus is still for a May-June 2015 tightening, a view the statement from this week’s  Fed policymakers meeting did nothing to dispel despite grumblings from a few regional Fed presidents that the target rate should be raised sooner and despite second-quarter inflation numbers that were reported the same day and came in right in line with Fed targets.

I think what’s most important for dictating the path of short-term rates is what happens with the employment, housing and inflation. The employment picture is pretty strong and continues to strengthen, but both inflation and housing have stuck in a sort of two-steps-forward, one-step-back mode. You’ll get good number on housing starts, then the home price drops in certain regions. You’ll get CPI up one month, then PPI down, or energy prices up and health-care down. It’s all fuzzy and a bit uncertain, and I think that’s the way rate policy will be for the time being.