Month in Cash: Forewarned is forearmed
As expected, Moody’s Investors Service last month completed its review of major global banks in the U.S., U.K., Germany, France and Switzerland, downgrading all of them from one to three notches on a long-term basis. The announcement, while clearly significant, did not meet with any real resistance or reaction from the marketplace, mainly because the moves had been priced into the markets long before. Moody’s announced the review in February, and in the four months since, the markets had plenty of time to adjust to the implications of a potential downgrade. The downgrades haven’t affected money markets much, either. The banks Moody’s downgraded to second-tier issuers are still rated as first-tier institutions by Standard & Poor’s and Fitch Ratings and, as a result, can still be used in money funds in accordance with SEC Rule 2a-7. That’s not to say that the money markets haven’t adjusted by reducing exposure to and shortening maturities within these institutions to account for the possibility that S&P or Fitch might review their ratings. For the time being, however, the impact of Moody’s downgrade has been minimal.
June also saw the Federal Reserve extend “Operation Twist”—purchases of longer-term Treasury securities with the proceeds from the sale of short-term Treasuries—in accordance with expectations. This represented the path of least resistance for the Fed. To do nothing might have caused market turmoil, while outright purchases would have resulted in a somewhat unpalatable balance sheet expansion. Faced with few effective options left for stimulus, extending a program that has generally been considered to be successful at keeping longer-term rates low, if not particularly effective at spurring economic growth, buys the Fed a bit more time to sort through whatever tricks it might have left in its bag and to develop consensus.
Money markets like to ‘twist’
For the money market world, Twist’s extension represented a rare case in which increased monetary policy stimulus didn’t hurt and, on the margins, actually helped. The sale of shorter securities in effect has put a floor beneath repo and Treasury rates, helping keep repo rates elevated while making Treasuries relatively more attractive compared with government agencies. Agency securities are fine; it’s just that with Treasuries having the benefit of this Twist-induced support, it makes sense to allocate more money in that direction than may have been the case otherwise. This is particularly welcome given that in the fourth quarter of 2011, money markets regularly faced overnight repo rates of one or two basis points and negative rates for Treasuries.
Overall, short interest rates—whether London interbank offered rates (Libor), repo, Treasuries or commercial paper—have remained very steady in this softening economic recovery. We’re still seeing enough issuance on the short end of the yield curve, and short-term commercial paper is sufficient to finance working capital needs, so it’s been steady as she goes. The lack of progress on unemployment has been a disappointment to the marketplace, but again, it hasn’t had a real impact on money market rates. We’re still growing, just at a slower rate, and the yield curve remains the same.