Tax-exempt money market funds continue to show signs of gradual improvement this week. The pace of outflows have slowed and the attractive high rates compared to taxable money market funds are enticing yield-starved investors looking for buying opportunities as Congress continues to grapple with the nation's current economic slump.
Even though tax-exempt money market funds lost $6.59 billion and settled at $479.84 billion for the week ending Sept. 29, that is a far cry from the $29.01 billion they lost the previous week when they settled at $486.43 billion during one of the most historically volatile periods for the financial industry, according to the Money Fund Report, a service of iMoneyNet.com of Westborough, Mass.
The 557 tax-free money market funds in the report continued to see declines as of Monday, following the substantial outflows that plagued the category last week and underscored the overall weakness in the municipal market in general. The outflows occurred as investors demonstrated a massive flight to quality in Treasuries. The volatility and uncertainty of the past two weeks caused short-term Treasury yields to plunge noticeably lower, while tax-free money market yields rose substantially higher.
The average seven-day yield on tax-exempt money market funds soared to 5.02% for the week ending Sept. 29. That was up from 3.67% in the prior week and 1.36% the week before - which was the largest increase for a one-week period, according to the Money Fund report. The boost in seven-day yields was again the result of variable-rate demand notes being offered at rates of up to 8% after being put back to dealers by tax-free and municipal money fund managers, the report said.
"If the money funds have an interest in seven-day demand notes, that will keep rates more reasonable, but not until the money funds want to buy them back will we see money market fund-eligible paper recover," said Phil Condon, managing director and portfolio manager at Deutsche Asset Management in Boston.
While investors continued to redeem shares of tax-free funds for a second week in row it was at a much slower pace - and some funds had massive inflows since a week ago Wednesday, according to one money market fund manager at a large, nationally recognized fund family.
"There are still a lot of problems, but the flows are up and a lot of money has come back into money funds," he said. "It started to increase significantly on Sept. 24, a few days after they announced that the Federal Reserve would insure all money market funds."
The manager said his funds were not hit with outflows as hard as some competitors, even at the height of the turmoil two weeks ago.
"People are being drawn in by the rates. There are cross-over buyers who are going to be in the money market fund space anyway, and who go back and forth between taxable and tax-exempt money markets," he explained.
"To the degree that those investors are not fleeing to the Treasury market or scared away altogether - and are going to be in the system anyway - they are choosing tax-exempt money market funds because of the high rates," the manager added.
The 1,303 taxable money market funds in the iMoneyNet report this week, meanwhile, showed more pronounced improvement. They accumulated inflows of $18.98 billion, which boosted assets for the week ending Sept. 30 to $2.858 trillion, compared to the prior week when they ended with $2.839 trillion after losing $91.44 billion, according to the report. The average, seven-day yields on taxable funds, meanwhile, fell to 1.62% from 1.80% last week.
Total assets of the 1,860 money mark funds increased this week to a combined $3.338 trillion, boosted by inflows of $100.06 billion into government money funds. By comparison, the industry suffered record outflows last week when both tax-exempt and taxable funds together lost a combined $120.45 billion and the funds settled at $3.325 trillion in total assets as the nation's fiscal crisis unfolded.
The biggest concern for tax-exempt money market fund managers, however, is the threat of massive outflows from the cross-over buyers once there is a resolution to the nation's fiscal crisis.
Market participants say market indicators show some signs of the short-term market returning to normalcy amid recent volatility, but the worst is not over yet.
Daily general market variable-rate demand notes have regained some strength as they declined to a 3.68% yesterday, after yielding a 5.77% last Thursday, down from a whopping 9.20% last Monday. The steady decline in yields indicates that the short-term market is recovering, according to a New York short-term trading manager.
"Funds seem to be getting money in here because of October coupons," he said. "We're hearing people clamoring for dailies. People want to stay super short and liquid - and they don't want to extent. Hopefully, we can see some sustainability in this [trend]."
Further improvement came this week as the VRDO market yielded a 6.01% yesterday, a noticeable drop from 7.96% last Thursday, which was down from 8.10% last Tuesday, according to Municipal Market Data.
Besides the wide spread between dailies and weeklies, the ratio between 30-day tax-exempt and taxable commercial paper was 113.9% as of yesterday, up from 100.0% on Monday, according to MMD.
Treasury prices were up yesterday as the investors and the financial markets digested the news that the $700 billion recovery plan gained Senate approval, and were awaiting a stamp of approval from the House expected today.
Yesterday, the Treasury market continued to rally, judging by the midday yields. The two-year note was yielding a 1.63% after yielding 1.82% late Wednesday. According to MMD, municipals due in 30 years are yielding 124.8% of the yield of U.S. Treasuries - the highest it has been over the three-month period between July 9 and Oct. 1.
