More On LIBOR, Money Market Fund Regulations, And Treasuries by Eric Bush, CFA – Gavekal Capital Blog
On October 14th the new money market fund regulations that were announced in July 2014 take effect. This has lead to a mass exodus out of prime and muni funds to the tune of about $700 billion since last October. The belief, according to this Bloomberg article, is that there could be another $300 billion that needs to get out before the regulations hit. The effect that this new regulation has had on USD LIBOR rates is already noticeable. The 3-month USD LIBOR rates is currently 86 bps which is 119 bps more than the 3-month EUR LIBOR rate, 90 bps more than the 3-month JPY LIBOR rate, and 49 bps more than the 3-month GBP LIBOR rate. Given the nearly perfect correlation between USD LIBOR and total assets in taxable government money market funds (which will continue to have a fixed NAV) and the nearly perfect negative correlation between LIBOR and total assets in taxable non-government money market funds (which will have a floating NAV), it seems safe to assume that 3-month USD LIBOR is set to rise above 90bps and could approach 100 bps before too long.
The result of this will most likely be higher 3-month LIBOR rate differentials when investors compare USD LIBOR to GBP/EUR/JPY LIBOR. As we discussed last week, this will drive up the cost of owning US treasuries for foreigners that wish to hedge the currency and ultimately reduce the currency hedged yield differential between US treasuries and other foreign government bonds. Presumably, this will reduce demand for US treasuries from foreign buyers. The latest TIC data (granted an always volatile series) indicates that this has already been occurring. The 1-year moving sum of net purchases of US treasury bonds and notes from foreign official institutions has fallen to -$343 billion. This is by far the lowest amount on record going back to 1979. To put this sum in a bit of context, the one-year moving sum peaked in August 2012 at over $230 billion. So foreign institutions have dramatically shifted from being a net buyer of US government debt to a large net seller of US debt over the past four years yet 10-year treasure yields have actually declined by over 100 basis during this period. There has always been a concern in the market of what would happen if foreign buyers moved stopped buying US government debt. This has now been going on for over a year and has yet to disrupt the treasury market.