Global rates may finally be heading up according to at least two indicators, while the historically wide spread between US prime and government funds may offer an opportunity for cash managers.
Those were two of several topics tackled by panelists participating in Treasury Strategies’ recent Quarterly Corporate Cash Briefing for 4Q 2016.
On the global-rate front, Steve Baseby, associate policy and technical director for the Association of Corporate Treasurers (ACT), said that corporate borrowing appears to have picked up, despite little need among issuers for additional cash. In addition, he noted, the UK 10-year bond yield nearly has doubled over a few months—increasing from 0.519 in August 7, 2016 to 1.081 October 23, 2016—and may be an early sign that rates are rising globally.
Baseby suggested that even though the 10-year yield is still relatively low, the quick rise has prompted issuers to borrow long-term to lock in rates.
“The fact that people are borrowing long when they don’t really need the cash is showing some concern or belief that this rate cycle is coming to an end, even if it only has to eventually,” he said. “The mood is that the [central banks’] low rate strategy is beginning to creak, and it doesn’t look as if it will hold. I think we’re at a turning point in the rates market.”
Nevertheless, rates on short-term investments have hardly budged, Mr. Baseby said, and that’s likely to be the case for some time still, given the amount of cash floating around the system. In fact, short-term rates in Europe are often negative. Mr. Baseby said that among ACT members, the rate is not the deciding factor for where to place cash short term, and despite having the choice whether to hold cash or not, currently they’re placing a priority on holding it.
“Moving to negative rates is just an increase in the cost of carry—it’s not really a move from positive to negative,” he said. He added that the reasons for their cash preference include wariness about whether the bank market will provide loans when required, in part stemming from a high level of political and regulatory uncertainty. In the wake of June’s Brexit referendum, he said, French, Dutch and German elections next year may impact the general political thrust of financial services regulation across Europe. In terms of Brexit proper, Mr. Baseby noted, the UK’s fate with respect to the European Union (EU) will be decided by 27 governments, “Many of which are annoyed with us for trying to leave.” And the Scottish National Party recently decided to put Scottish independence back into play, which could trigger other defections.
As far as regulations, the phase-in of CRD IV, the EU’s version of the Dodd-Frank Act, could affect pooling, Mr. Baseby said, and the EU’s own money market fund reforms on the horizon are likely to take similar form to the US’s.
Anthony Carfang, managing director of Treasury Strategies, a division of Novantas, noted Libor’s steady climb since last December—three-month Libor up more than 25 basis points over that period, and one-year Libor up more than 40 bps—caused by in large part by outflows from US prime institutional funds as money market fund (MMF) reform approached.
“That shows a bit of stress or tightening in the market,” Mr. Carfang said, adding that between $7 trillion and $10 trillion in debt globally and ISDA’s estimate of $350 trillion in derivatives is priced off Libor. As a result, municipalities as well as universities and hospitals have seen their borrowing costs soar, he said.
Another outcome from MMF reform has been funds moving away from prime funds into government funds, between which there’s been an average spread historically of 15 bps to 17 bps, said Deborah Cunningham, chief investment officer, global money markets at Federated. She added that prime products that don’t face the restrictions of the Investment Company’s Act’s Rule 2a-7 but are otherwise identical in terms of how they invest instead yield an additional 50 bps over government MMFs.
“That [additional yield] will ultimately be realized by prime 2a-7 funds,” Ms. Cunningham said, adding that she anticipates little change in the fourth quarter, “But it’s certainly going to represent extreme value, especially compared to what is available in the Treasury and government worlds from a yield standpoint.”