One of the biggest winners in the push to make money-market funds safer for investors is turning out to be none other than the U.S. government.
Rules adopted by regulators last month will require money funds that invest in riskier assets to abandon their traditional $1 share-price floor and disclose daily changes in value. For companies that use the funds like bank accounts, the prospect of prices falling below $1 may prompt them to shift their cash into the shortest-term Treasuries, creating as much as $500 billion of demand in two years, according to Bank of America Corp.
Boeing Co., the world’s largest maker of planes, and the state of Maryland are already looking to make the switch to avoid the possibility of any potential losses. With the $1.39 trillion U.S. bill market accounting for the smallest share of Treasuries in six decades, the extra demand may help the world’s largest debtor nation contain its own funding costs as the Federal Reserve moves to raise interest rates.
“Whether investors move into government institutional money-market funds or just buy securities themselves, there will be a large demand” for short-dated debt, said Jim Lee, head of U.S. derivatives strategy at Royal Bank of Scotland Group Plc’s capital markets unit in Stamford, Conn. “That will lower yields.”
He predicts investors may shift as much as $350 billion to money-market funds that invest only in government debt.
During the past five years, America has enjoyed some of the lowest financing costs in its history as the Fed held its benchmark rate close to zero and bought trillions of dollars in bonds to restore demand after the credit crisis.
Based on prevailing Treasury bill rates, it costs the U.S. just 0.015 percent to borrow for three months as of Monday. In the five decades prior to 2008, the average was more than 5 percent.
Now, with traders pricing in a 58 percent chance the Fed will raise its overnight rate, speculation is building that borrowing costs are bound to increase. That’s made finding buyers for the nation’s debt securities even more important.
The sweeping rule changes in the money-market fund industry may help provide that demand.
Since 1983, money-market funds have been permitted to keep share prices at $1, meaning a dollar invested can always be redeemed for a dollar.
Institutional prime money funds, which invest in short-term IOUs issued by companies known as commercial paper, are among the funds that will now have to report daily prices which may fluctuate based on their underlying holdings, according to rules adopted July 23 by the Securities and Exchange Commission.
The SEC will also give the funds the ability to impose fees on redemptions and lock up investors’ money for as long as 10 days when a fund faces an inability to meet redemptions.
The changes are intended to prevent a repeat of 2008, when the collapse of the 37-year-old, $62.5 billion Reserve Primary Fund triggered a run on other money funds and deepened the worst financial crisis since the Great Depression.
Still, investors using prime funds to manage their idle cash may find floating prices an unnecessary risk when differences in fund rates are so minimal, said Brian Smedley, an interest-rate strategist at Bank of America in New York.
He estimates about half the $964 billion held in institutional prime funds will flow into those that only invest in government debt and yield about 0.013 percentage point less, before the new rules become fully effective in 2016.