Money Market Funds Are Getting Ready for a Debt-Ceiling Debacle

Pity the money market funds.

Not only have they been dealing with years of low interest rates and new regulation introduced after the 2008 financial crisis, but they’re also now staring down the barrel of yet another debt-ceiling debacle.

Money market funds tend to act as an alternative to bank deposits by investing in short-term securities like commercial paper or Treasury bills, which means avoiding volatility or losses is absolutely paramount for the funds’ ultra-conservative investors. As debt-ceiling dates approach, these investors have historically tended to pull money out of money market funds for fear of a technical default that could send yields on T-bills soaring.

In fact, one estimate from Barclays Plc claims that higher bill yields cost taxpayers an extra $40 million to $70 million in 2013, when debt-ceiling fears helped push T-bill rates to their highest since 2008. (That means politicians claiming to care about fiscal prudence may actually ended up costing the U.S. more money through political brinkmanship or dithering, although it’s worth noting that the added cost of higher T-bill yields could well have been offset by lower yields on longer-term U.S. Treasury debt.)

In any case, given the U.S. Treasury may be running out of money as soon as mid-October, money market fund managers are once again trying to minimize potential damage by shortening the maturity of the debt instruments they invest in, or turning to repo markets to finance more short-term transactions. The idea here, per JPMorgan Chase & Co. fixed income analysts led by Alex Roever, is that shorter-term assets and transactions can be more easily liquidated if the fund needs to satisfy investor withdrawals:

Of course, money market funds can also park excess cash in the Federal Reserve’s Reverse Repo facility (RRP), which has already seen a massive uptick in usage with a record $1.35 trillion reached last week. As Credit Suisse AG Strategist Zoltan Pozsar put it on a recent Odd Lots episode, the RRP acts as “a mechanism that enables the system to kind of clear,” allowing excess cash that can’t be handled by banks due to balance sheet constraints to flow into money market funds and on into the Fed facility instead.

With the possibility of another political showdown over U.S. debt limits looming, even more money is expected to shift into the RRP.

“Suddenly, $1.5 trillion of Fed RRP usage doesn't appear unreachable,” conclude the JPMorgan analysts.

Related links:
The Craziest Thing About Debt Ceiling Drama Is Its Impact on Bonds
Transcript: Zoltan Pozsar on What’s Going on in Rates Markets