Market Extra: Here’s a $4 trillion reason why investors think negative rates are a no-go for the U.S.
Negative U.S. interest rates would hurt the money market fund industry
Don’t bet on negative interest rates in the U.S. anytime soon.
Even as some traders speculate the Federal Reserve will push interest rates below zero by year end, analysts say the intense pain that the policy would inflict on the crucial $4 trillion money-market fund industry would ultimately give Fed officials second thought.
“Nobody at the Fed wants to take the fed funds rate negative given the side-effects on banks and money funds,” said Krishna Guha, vice chairman at Evercore ISI, in a note.
Based on trading in the fed fund futures market where traders can bet on changes in the central bank’s benchmark interest rate, some see the chance of interest-rates turning negative next year.
Yet Fed officials have publicly pushed back against the use of subzero rates, amid worries how it could upend parts of the U.S. financial system.
In particular, money-market funds are seen as vulnerable to negative interest rates and bond yields.
A cornerstone of Wall Street’s infrastructure, money-market mutual funds will buy very short-term debt from highly rated companies, banks, governments and municipalities, providing them with a key source of cash. In return, investors of money-market funds get to put their cash in a highly liquid and safe asset which should hold its value throughout the ups and downs of financial markets.
Yet negative interest rates can erode the yield earned in such funds as they invest in safe debt securities that carry skimpy yields. Taking fees into account, investors could, in theory, end up losing a small but insubstantial part of the original funds they had put in.
“We have a money market fund industry whose business model would come under severe strain if rates were negative. Reworking the MMF industry would be extremely disruptive,” wrote Michael Cloherty, a rates strategist at UBS.
But some veterans of the industry feel negative interest rates were a manageable issue.
They point out that overall European money market fund industry grew throughout the European Central Bank’s experiment with negative rates after the eurozone crisis.
“It would be uncomfortable, but money market funds could operate with negative rates,” said Peter Crane, president of Crane data, which tracks the money market fund industry.
If money market funds felt negative interest rate policy was temporary, they could waive fees to ensure returns earned from the funds stayed positive while waiting for the economy to recover.Fidelity, for example, says it would waive certain fund fees to prevent returns from money market funds falling below zero.
And in the aftermath of the financial crisis of 2008, funds did just that when interest rates fell to rock-bottom.
Industry revenues fell to less than $4 billion in 2013, from about a pre-crisis level of $9 billion. They later recovered to around less than $7 billion in 2016, after the Fed raised interest rates in the December of that previous year, according to BNY Mellon.
Companies and investors also had few alternatives to park large sums of cash. One chief appeal of market funds was that an investor could pull their money out swiftly without losing much.
“Anyone suggesting cash in the mattress clearly hasn’t thought through that option. Holding physical cash is not an option for IBM,” said Crane.
He added the loss of principal resulting from negative yields were easily overshadowed by other considerations such as the cost of buying and selling the fund, and the bugaboo of all cash and bond investors — inflation.
Crane warned, however, there would need to be regulatory tweaks and changes to how money market funds operated for the industry to adjust to a new normal of negative rates.
In other markets on Friday, the S&P 500
and Dow Jones Industrial Average
were on pace to close sharply higher for the week as investors appeared to look through the economic devastation wrought by the coronavirus. The 10-year Treasury note yield
climbed 4.9 basis points to 0.680% on Friday.