Money market funds, flush with deposits after investors sought safety during last month’s banking turmoil, are now confronted by the political stand-off over the US debt ceiling that threatens to disrupt their investment portfolios.
More than $440bn has poured into US money market funds since early March, according to data provider EPFR, in the wake of Silicon Valley Bank’s collapse, and as attractive returns drove investors out of ordinary deposit accounts.
Those inflows have largely flooded into government money market funds, which invest heavily in short-term Treasury debt that is typically easy to buy and sell. The debt offers the best yields in years because of the US Federal Reserve’s aggressive campaign of interest rate rises.
While the US is not expected to default on its obligations, a prolonged stand-off in Washington over raising the federal borrowing limit could create difficulties with buying and selling this short-term debt, potentially leading to some losses for money funds. The alternative to buying Treasury bills — stashing cash overnight with the Fed — could add to strains in the banking system.
“The debt ceiling should be something the money market funds industry is worried about,” said Steve Sosnick, chief strategist at Interactive Brokers. “Though I don’t think the US will be unable to pay its bills, there might be a liquidity crunch in there.”
Concerns about a debt ceiling crisis have picked up this month as the US tax deadline of April 18 comes into view. The revenue collected this year will help determine how much longer the US can pay its bills before running out of money, since a divided Congress failed in January to raise the government’s borrowing limit.
Investors are expecting the fight to go down to the wire as a stalemate between the White House and the Republican party looks unlikely to be resolved before the threat of default becomes imminent late summer.
The debt ceiling debate “could be a big issue” in particular for government money market funds, according to Andrzej Skiba, head of Bluebay US fixed income at RBC Global Asset Management.
“You could easily see a scenario where if the US government’s ability to borrow is exhausted in the midst of this crisis, then that creates quite a lot of volatility for money market funds — it can increase withdrawal demands, it can just create a lot of noise around the issue.”
There is not yet consensus on the exact moment at which the government will run out of cash. April tax collections of $300bn or below could bring the debt ceiling deadline forward to June or July, according to Praveen Korapaty, chief interest rates strategist at Goldman Sachs, “somewhat earlier than many people had thought”. He added that most expect larger collections.
Investors have already started avoiding bills that mature in late July and early August — around the time that experts generally think the US may run out of money. An auction of three-month Treasury bills this week was met with poor demand.
Owning these less desirable securities is not a problem if the funds hold them until maturity, provided that the debt ceiling fight is resolved in time for the US to pay its bills. But problems arise if customers pull money out of those funds — either for normal business reasons, or because of panic about the debt ceiling. In that instance, money funds may have trouble finding buyers for the securities and be forced to take losses.
Assuming the “crunch point” for the government to service obligations lands between July and August, Skiba said, “you’re just going to make sure you don’t own T-bills maturing around those months within your portfolio”.
“If you look at the examples in the past,” he said, “it’s primarily Treasury bills that were maturing around the time of the debt ceiling that exhibited the biggest volatility.”
The surge of cash into money market funds has also meant that those funds have increased their usage of a Fed programme that allows them to invest cash at the central bank overnight for a 4.8 per cent return. Treasury bills are in relatively short supply at the moment, so money funds have stashed some of the floods of cash coming in to the overnight reverse repo facility (RRP), which is currently getting roughly $2.3tn a day.
If worries about the debt ceiling reduce the number of Treasury bills money funds are willing to buy, that could push even more cash into the RRP. And the ballooning size of the RRP facility may add to banking strains, some experts have warned.
Korapaty said: “Once the debt ceiling is raised, you’re going to see the Treasury issue a tonne of bills. Money funds will then be able to buy these bills and not shovel quite as much money to the RRP, and so that should actually provide some relief in the other direction.”
