Repo Pullback Impacts Money Market Funds

A pullback in low cost overnight funding at banks isleading to changes in the money market mutual fund market.

On Wall Street

October 6, 2014

 

By Robert Stowe England

New capital and liquidity rules are forcing banks to pull back from a vibrant market that has allowed them access to inexpensive overnight funding.

With the decline in funding volumes come potential outcomes that impact the $2.591 trillion market for money market mutual funds.

“There are ripple effects,” says Joseph Abate, a money market strategist at Barclays PLC in New York. “The first ripple effect is there is a significant shortage of safe assets for cash-long investors to buy.”

During the past two years, banks have been steadily reducing the volume of repurchase agreements, known as repos, that have served as a significant source of liquidity but which regulators see as an unreliable funding source for banks during crisis periods.

In this situation, money market funds may find themselves scrambling to find enough repo, which forces the funds to use an overnight reverse repo facility run by the Fed. This also keeps interest rates down on bills and other short-duration instruments as well.

“That may or may not be a bad thing. However, it does create a disconnect in the market,” says Abate. Such a disconnect in the market could have significant drawbacks. “If there is not enough to buy, you artificially bid up the price of assets. You also encourage banks and others to create assets that meet that demand but that are not government safe assets,” says Abate.

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Robert Stowe England is an author and financial journalist who has specialized in writing about financial institutions, financial markets, retirement income issues, and the financial impact of population aging.

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