US-Europe divide on 2016 outlook for money funds

North America and Europe still comprise most of the demand for money fund products, but appetite is growing in other world markets such as China, reports Fitch Ratings.

In its newly-released report, entitled ‘2016 Outlook: Money Market Funds’, the credit ratings agency (CRA) notes that China now represents 8.5% of global money fund assets, which total US$4.6 trillion.

Fitch has maintained its stable outlook for the sector, reflecting what it reports to be money fund managers’ active management of credit, market and liquidity risks. “However, the sector faces several headwinds, including low or negative yields, constrained investment supply, and the impact of regulatory reform globally,” the agency comments.

The CRA expects further consolidation of money funds and asset managers active in the market during 2016 as implementing market reforms couple with sustained low yields make their impact.

“The low yield environment is particularly acute for euro money funds, even as investors are beginning to accept negative euro money fund yields due to the lack of alternatives,” Fitch comments.

Earlier this month, the agency said that investors were returning to euro-denominated money market funds (MMFs), even though they had been delivering negative interest rates since the European Central Bank (ECB) launched its bond-buying programme in March this year. These funds, which are popular with company treasurers and usually provide a modest positive yield above cash, are some of the most conservatively run in Europe.

However, this year’s quantitative easing (QE) pulled European short-term interest rates into negative territory, forcing investors to accept losses on euro-denominated constant net asset value (CNAV) MMFs that retain a fixed €1-a-share unit price.

Yields on euro CNAV funds turned negative in April and the assets held in them fell by 20% to €68.7bn over the quarter to the end of June. However, more recently the outflows have halted as investors begin returning to the products and the total recovered to €72.1bn over the third quarter of 2015.

Atlantic divergence

The situation is different in North America, where US fund managers are repositioning cash management offerings ahead of money fund reforms taking effect, says Fitch. It expects this to trigger greater demand for alternative liquidity products, as well as a shift to government assets “as investors reassess floating net asset value (NAV)/US prime money funds.” Discussions on money fund regulation in Europe are still ongoing and the final form and timing are still unknown.

The next 12 months are also likely to see a divergence of interest rate paths in the US and the UK against that of the eurozone.

“Money funds will shorten their duration in anticipation of their expectations of the Federal Reserve and the Bank of England [BoE] to start raising rates in late 2015 and 2016 respectively,” says Fitch. “The European Central Bank [ECB] continues to ease monetary policy, forcing euro funds to contend with negative yields.”

The agency believes that banks will continue to be major issuers for money funds, although declining in portfolios’ allocation as the Basel III capital adequacy regime discourages banks from obtaining short-term funding.

Fitch also predicts that money funds will also continue to shift allocations more to securities issued by sovereigns, supranationals and government agencies (SSA) and non-financial corporates, while the larger US money funds will also be attracted to the Federal Reserve’s reverse repurchase agreement programme as the US begins to lift rates that have been close to zero for the past seven years.

“The expected flows into government money funds in the US will pose a challenge as the available supply and yields on government assets remain low,” it concludes.

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