Month in Cash: Nothing spooky about stability

11-01-2018

Halloween is only one night, but the risk markets had an entire month of scares in October. Of course, liquidity vehicles such as money market funds tend to benefit in times of volatility. But added to this relative stability in the month were underlying developments that showed the sector’s strong fundamentals.

One comes in the form of the Federal Reserve’s ongoing quantitative tapering (QT). In the last 12 months, the Fed has been decreasing its massive holdings of Treasuries and mortgage-backed securities by reducing reinvestments. The central bank started modestly, allowing $30 billion to roll off its balance sheet in the fourth quarter of 2017. It increased that amount by $30 billion every quarter that followed. The total for the present quarter will be $150 billion, meaning the balance sheet declined by as much as $50 billion in October. This kind of acceleration has the potential to be destabilizing, so it is odd the Fed has not announced if it will extend the pattern in 2019. However, recent behind-the-scene indications are that policymakers feel capping it at $50 billion a month is appropriate for now.

This is significant not just because of the dollar amount and the predictability, but because QT is now at a high enough level as to be a meaningful policy tool if used in conjunction with the federal funds rate. If the Fed wants to loosen or tighten policy, it could reduce or raise the pace of QT along with lowering or raising target rates.

Speaking of rates, despite criticism from a certain executive, a Fed hike is baked into the cake for December. There is talk of a “pause” in rate action in 2019, and no consensus of what the range will be at the end of 2019. But for the present, rates are predictable and that is a good thing. Yields on money funds were steady in October across the industry.

Despite the disrespect both strong earnings and economic indicators seem to be getting from the stock market at present, money markets are benefiting from the economy's health. To this point, a good portion of the flows into prime products are not coming from government money funds but from other liquidity vehicles such as banks and longer-term equity and fixed-income funds. While the cash sphere is a haven in times of volatility and stress, that’s a sign its attractive yields are enticing inflows. Money market funds clearly have momentum. For those institutions still able to use prime funds after reform but chose not to, the yield spread is making a good argument to return.

One final word on the Fed. It is now so close to its own solid ground. The top three positions—chair and two vice chairs—are now in place and a full complement of governors is in reach if nominees Michelle Bowman, Nellie Liang and Marvin Goodfriend are confirmed. Almost there.

The weighted average maturity (WAM) target ranges of our funds ended October with prime and municipal funds in a 30-40 day span and government funds in a 25-35 day range. The London interbank offered rate (Libor) rose over the month, with 1-month at 2.26% to 2.30%, 3-month at 2.40% to 2.52% and 6-month at 2.60% to 2.78%.