Euro-denominated money market funds have already taken investment and operational measures to prepare for yields declining or even turning negative, should short-term money market rates shift in that direction following the European Central Bank's decision to cut the rate on its deposit facility to minus 10bp, Fitch Ratings says.
Euro constant net asset value (CNAV) MMFs adopted structural share class changes following the cut in the ECB deposit rate to zero in July 2012. The changes allow them to maintain a stable net asset value per share should a fund suffer a negative net yield. Euro MMFs also updated their investment objectives to introduce the concept of relativity to prevailing money market rates.
Yesterday's ECB negative deposit rate move and cut in the main refinancing rate of 10bp to 0.15%, effective 11 June, is likely to push MMF yields back to near zero levels. MMF net yields had ticked up to reach 18bp on average at end-May across euro CNAV MMFs, from a trough in February 2013 at 2bp.
The cut in the ECB's deposit rate will push the Euro overnight index average (Eonia) lower, but the risk of MMF yields turning negative is lower now than 18 months ago, when the eurozone liquidity was under stress. A flight to quality to core Europe from the periphery resulted in negative short-term market rates for highest quality issuers during this period. Current market rate levels means that most MMFs do not anticipate difficulties placing short-term cash.
MMFs are likely to continue to look for yield-picking investment opportunities with longer dated assets, taking advantage of the steeper yield curves since end-2013. Euro MMFs have increased their allocation to assets with maturity of more than three months, during the first five months of the year. This move was most pronounced in May as most funds anticipated the ECB rate cut. MMFs' portfolios average lives extended to 58 days on average at end-May 2014, ten days longer than at the beginning of the year.
Should Euro MMFs post negative yields resulting from short-term market rate moves, this would not be a negative for MMF ratings by itself, including 'AAAmmf'. MMF yields have to reflect prevailing safety and liquidity costs, commensurate with alternative high quality short-term instruments. Fitch's MMF ratings are a ranking of funds on the basis of their liquidity, market and credit risk profiles.
It is unknown how investors will react to the likely decline of MMF yields in the current less risk-averse market environment. They may elect to switch to higher yielding products, trading off liquidity, spread sensitivity and credit quality for higher yields.
For more details on the impact on Euro MMF ratings, see 'Fitch: Potentially Negative Euro Yields Won't Impact MMF Ratings' dated 18 September 2012 at www.fitchratings.com.
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