Posted by Lawrence Gillum, CFA, Chief Fixed Income Strategist
Tuesday, May 16, 2023
After years of waiting for cash to be a viable asset class again, investors have flocked into money market funds to take advantage of higher Treasury yields. In fact, with over $5 trillion in assets, money market assets under management have never been higher. However, with the ongoing debt ceiling drama in Washington, investors may be concerned about the prospects of delayed payment on Treasury bills (T-bills), which generally make up a sizable allocation within certain money market funds (MMFs). Aggregate data shows that money market fund managers are taking the potential of delayed payment seriously and have been positioning portfolios defensively. Many (not all) managers have been utilizing the Federal Reserve’s (Fed) overnight reverse repo facility (ON RRP) and are selectively adding T-bills that mature outside of the x-date.
The Fed’s ON RRP facility allows certain MMFs to borrow from or lend to the Fed, using government securities as collateral and agreeing to buy or sell back those securities at rates set by the Fed, on an overnight basis. As seen in the chart below, balances at the ON RRP facility remained elevated with over $2 trillion parked there (as of May 15, 2023). Collectively, 95% of the usage of the facility comes from MMFs: Government MMFs made up about 79% of the uptake, prime MMFs close to 16%, and non-MMFs about 5%. With an aggressive rate hiking campaign by the Fed and the ongoing debt ceiling drama in Washington, the Fed’s facility remains an attractive (and comparably risk free) alternative to options in the short end of the Treasury market.
Additionally, as further precautions, MMFs have been cautious with T-bill allocations by opting for bills that mature outside of the so called x-date. In particular, according to JPMorgan, government MMFs kept investments in T-bills maturing in June through August relatively low as of April-end. Anecdotally, we see this in the nearly 1% difference in yields between bills that mature on May 30 and those bills that mature after June 1, as investors are demanding additional compensation for the risk of delayed payment.
Our base case remains that Washington will do the right thing and raise the debt ceiling—like it has every single time before. President Biden and House Speaker Kevin McCarthy are scheduled to meet today to continue debt ceiling negotiations, and we’re hopeful further progress will be made. These games of political chicken can introduce volatility to markets in the near term, but we do not think MMFs, in aggregate, are at increased risk of liquidity issues due to a possible technical default of U.S. Treasuries (which again we think is a very low probability). For more information on the debt ceiling, check out our February 27 Weekly Market Commentary.
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