Money Market Funds See Opportunity In ‘Sterilized’ Easing

By Anusha Shrivastava and Cynthia Lin

Money-market fund managers say “sterilized” asset purchases under consideration by the Federal Reserve are their newest hope to lift returns out of the gutter.

The Fed is considering buying long-dated Treasury bonds and simultaneously borrowing the money back for short periods of time, the Wall Street Journal reported last week. The program aims to stimulate the economy by keeping down borrowing costs.

It would also create a new pool of high-quality, short-term debt. These assets are in short supply since Europe’s sovereign debt troubles made much of the continent’s debt too risky for money market funds.

Instead, these mostly conservative funds that manage nearly $3 trillion have had to compete for Treasury bills, pushing yields here near zero or even negative territory. Many funds have cut fees to avoid losing investors, and some have closed. Fund managers say sterilized easing would boost yields on short-term debt of all types and help rev up returns.

“It’s been painful for them,” said Jefferies money-market economic Tom Simons. “You’re talking about a good year that they’ve had to suffer low returns. Even the prospect of something where they can earn more money is something to look forward to.”

Since the Journal report, the yield on the six-month Treasury bill has shot up about 30%, trading near a seven-month high at 0.145% on Thursday. The yield was as low as 0.04% in January.

Money funds aren’t benefiting from the current round of easing. Dubbed “Operation Twist,” the Fed is buying long-dated Treasurys and selling short-dated notes. Only the 21 “primary dealer” banks transact with the Fed.

In a “sterilized” easing program, the central bank would offer short-term debt with an agreement that the buyer sell it back to the Fed at a later date, an arrangement known as a reverse repurchase agreement. It could set the repurchase terms over a shorter period — seven to 28 days for instance — allowing money market funds to participate directly.

“Sterilized QE may improve the functioning of money markets by allowing a broader set of financial institutions to be counterparties to the Fed’s balance sheet expansion,” wrote Goldman Sachs economist Zach Pandl. Goldman expects the Fed to take this easing route.

The Fed would also need to offer at least 0.250% on these repos, the rate banks can receive for depositing their cash with the central bank, said Michael Lin, director of U.S. funding and repo at TD Securities. Otherwise, banks would have no incentive to buy the new debt, he said.

By contrast, a one-month Treasury bill yields 0.05%.

“When you have a new high quality issuer with a large amount of supply, it would be natural to assume that other rates would change,” said Joseph Lynagh, portfolio manager for money-market funds at T. Rowe Price.

To be sure, the Fed could decide not to pursue sterilized easing. The central bank’s policymaking group didn’t offer hints about the possibility of new stimulus in its latest policy statement released Tuesday.

Some bond strategists, including those at primary dealer RBC, say the Fed will ultimately scrap this idea because selling reverse repos could crowd out borrowers like European banks that already have trouble accessing the market, in part because money market funds avoid their debt.

But given U.S. economic data has improved recently, it is increasingly possible the Fed will take the sterilized approach. And it would be greeted by an eager group of buyers.

“It is very likely that if the Fed chose to sterilize in this fashion, there would be willing buyers because the counterparty is stellar,” said Deborah Cunningham, chief investment officer at Federated Investors in Pittsburgh, adding that her firm’s eight eligible money funds will very likely buy the Fed’s new offering.