The madness continued in June as markets convulsed on economic and political surprises. As the month began, investors were debating whether the Federal Reserve would raise rates at its mid-month meeting, with committee members seeming to prepare investors for an imminent rate hike. That view quickly reversed with the release of the May employment report which showed a tepid gain of only 38,000 new jobs (subsequently revised lower to 11,000). With that outturn, the conversation shifted from worry that the economy was on the verge of overheating to fear that the economy was again at risk of recession. Despite that fear, stocks and bonds traded sideways for much of the first half of the month. Of mild concern was the British referendum on continued membership in the European Union, colloquially referred to as BREXIT. Despite warnings of financial catastrophe should the British vote to terminate membership, concern seemed to fade as the vote approached. However, the United Kingdom shattered the calm and surprised the world by voting to leave the Union, causing global stock prices to plunge, led by European banks. In an effort to stabilize markets, the European Central Bank assured investors that the banking system would remain solvent. The British Pound collapsed by more than 10% on the news and continues to remain under pressure at the time of this writing. Prime Minister David Cameron added to the confusion by announcing that he would tender his resignation in October, citing his disagreement with the outcome of the vote. That decision was a double-edged sword as it would mean that exit negotiations would not commence immediately, as preferred by the members of the EU, and would result in a three month void in leadership. However, since the vote, much has changed. David Cameron has been replaced by Theresa May as Prime Minister, and investors have concluded that the exit would be more orderly than at first feared. On the back of that and renewed belief of further global Central Bank stimulus – the S&P 500 reached a new all-time high on July 11, eclipsing the previous high set last summer and coming on the eve of earnings season. Investors seem to be concluding that the economic impact of the “Brexit” would not have the global impact that was feared. Moreover, the 287,000 increase in nonfarm payrolls gained reported in July indicates that the US economy is not on the verge of rolling over as was feared in late June.
We’ve written about the coming changes to Prime money-market funds on several occasions since the Securities and Exchange Commission mandated the rule changes two years ago, and with the October deadline rapidly approaching, thought it relevant to again highlight the new rules. The most significant change, at least initially, is that Institutional Prime money-market funds will no longer be allowed to maintain a stable Net Asset Value and will, instead, be required to allow the NAV to float. In addition, all fund companies, individual as well as institutional, will be allowed to temporarily block investor redemptions, also known as gating, and impose a redemption fee of as much as 2% in the event of a mass exodus of investors. Such an exodus would be defined as a 10% fall in assets under management over the course of one week. When investors come to understand that a 200 basis point fee could be imposed on a money market fund that’s paying them no more than a handful of basis points, they’re likely to look for an alternative.
The likely alternative to Prime funds would be U.S. government MMF’s, funds that invest only in U.S. Treasury, GSE (Fannie Mae and Freddie Mac) debt and repurchase agreements. Those funds will be required to hold at least 99.5% of their assets in government paper, that’s an increase from the current minimum of 80%. Additionally, U.S. government MMF’s will not be subject to the mandatory redemption gate or fee imposed on Prime MMF’s. That is unless the board of the fund decides that a gate or a redemption fee is needed, in which case they can apply either or both. It’s estimated that approximately $350 Billion in Prime money market funds will migrate to government only money market funds by the October deadline. We are watching for opportunity as those funds become forced sellers of corporate paper and buyers of government-related debt.