Outflows have continued to slow and more new cash has begun to find its way back to tax-exempt money market funds over the last week.
Investors gained added encouragement when the Federal Reserve Board joined central banks around the world Wednesday in lowering interest rates, which came on the heels of last Friday's passage of the historic $700 billion federal bailout package.
Tax-exempt money market funds gained $4.90 billion during the week ending Oct. 6, and settled at $484.74 billion. That is a noticeable improvement from the previous week when the funds lost $6.59 billion amid tension over the House vote and settled at $479.84 billion for the week ending Sept. 29, according to the Money Fund Report, a service of iMoneyNet.com of Westborough, Mass.
Since then, the industry has seen a reversal of the prior three weeks during which massive outflows plagued money funds as investors - trying to escape the unprecedented market volatility and uncertainty - took shelter in the Treasury market, causing short-term government yields to plunge in the face of substantially rising tax-free money market yields. This week, the positive flows into tax-exempt money market funds are an indication that investors are somewhat calmer following passage of the bailout package.
While the money market industry is still facing some volatility, outflows have slowed by a wide margin, and inflows have been sporadic over the last two weeks, indications that funds are poised for further improvement and stabilization, according to Mary Jo Ochson, chief investment officer of municipal money markets at Boston-based Federated Investors.
"We have been seeing some cash inflows into the money funds," she said, especially with the rate cut by the Fed following the approval of the federal rescue plan - which includes the government guaranty on all money market funds - as well as recent consolidations in the banking industry that helped give investors an added layer of comfort over the last week or so.
"There are a lot of counterparties at banks that have been purchased by other banks and merged with other banks, so there are less financial institutions left, but they are stronger and that's calmed investors," she explained. "All of these actions coming together will continue to stabilize the market."
Ochson said her firm's tax-free money funds hold securities of high quality and minimal credit risk and maintain a barbell structure with seven-day floaters on the front end and general obligation bonds on the long end - all of which helped maintain liquidity to handle redemptions when the market turmoil unfolded three weeks ago and the massive outflows began.
She said a decline in the yields of major short-term market indicators fueled by the slowing pace of outflows is continuing to provide evidence of overall recovery. For instance, she noted that the Securities Industry and Financial Markets Association weekly swap index, which tracks seven-day tax-exempt variable-rate demand obligations, has been steadily creeping down from its recent highs. It dropped to a 5.74% on Oct. 1, down from its high of 7.96% the prior week, and the week before that it rose to a 5.15% after being at a 1.79% on Sept. 10.
Although the spread between daily and weekly short-term floaters has tightened slightly, it still remains attractive. Daily general market VRDOs declined to 2.46% yesterday, after yielding 3.69% last Thursday, according to Municipal Market Data. That was down from 5.77% the prior week and a whopping 9.20% back on Sept. 22.
The weekly VRDO market, meanwhile, yielded a 5.07% yesterday after yielding 6.01% last Thursday, which was a noticeable drop from 7.96% the week before, and 8.10% on Sept. 23, according to MMD.
In addition, the ratio between 30-day tax-exempt and taxable commercial paper was 75.9% as of yesterday as compared to 113.6% last Thursday, according to MMD.
While tax-exempt money market fund rates have also fallen, they are still attractive compared to taxable money market funds, Ochson said.
The demand for money funds - and a yield decline in the VRDN market - caused the average seven-day yield on the 556 tax-free and municipal money market funds in the report to drop to 4.33% from 5.02%., according to the report. By comparison, the average seven-day yield for all taxable money funds slid to 1.47% from 1.62% for the week ending Oct. 7.
All money market funds managed to post gains this week and avoided a wholesale sell-off of short-term floaters back by letters of credit.
Overall, the total combined assets of the 1,841 money market funds rose by $49.39 billion in the week ending Oct. 7 and settled at $3.38 trillion, up from $3.33 trillion last week, according to the report. Meanwhile, taxable money market funds are pulling in cash for the second week in a row.
The 1,285 taxable funds in the report gained $44.49 billion to end the week of Oct. 7 with $2.90 trillion in total assets, compared with the previous week when they took in $18.98 billion and ended at $2.85 trillion. That was a stark difference from losing $91.44 billion and settling at $2.83 trillion at the height of the market turmoil during the week ending Sept. 23.
Some analysts said if money fund managers make a sweeping decision to put back related floaters, that could cause another sharp rise in floating rates and an overall contraction of the money fund industry. Others expected that the government intervention of the financial institutions would likely appease managers enough to convince them to hold their short-term floaters with LOCs from the affected entities due to the lack of money market fund-eligible securities in the market.
Ochson would not comment on her decision to hold or put back floaters with Dexia Group or Depfa Bank PLC liquidity. She said to protect the quality and liquidity of her funds going forward, analysts constantly monitor the credit quality, risk, and liquidity providers of the securities in the portfolios - a routine task that has taken on new importance given the ever-changing global financial crisis.
"Every day you own anything you have to make the judgment of whether it has minimal credit risk - every single day, every single credit has to go through a review processes, and you have to analyze it in real time and whether to buy, sell or hold," Ochson said.
"Both bonds funds and money market funds are equally challenging, but the old days of thinking that managing a money market fund was easy is out the window," she said.