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Institute Alert

Wells Fargo Investment Institute strategists provide insights on this week’s market volatility and guidance for what may be ahead.

July 26, 2021

W. Carter France, CFA, CAIA, Senior Investment Analyst Global Manager Research

Luis D. Alvarado, Investment Strategy Analyst Global Investment Strategy

The state of money market yields following Fed action

Key takeaways

  • The Federal Reserve’s (Fed’s) actions taken in June 2021 served to slightly increase the yield of certain securities held in money market funds. Money market fund yields remain positive, and the slight increase in yield has been supportive of fund net asset values, which have generally remained slightly above $1.
  • Money market yields have declined notably since the Fed reduced the federal funds rate in early 2020. Current expectations are that the Fed will keep rates at low levels with the first rate hike coming in early 2023.

What it may mean for investors

  • Although the Fed’s actions in June 2021 resulted in a slight increase in the yields of money market funds, we do not expect that increase in yield to be realized by investors. Rather, we expect money fund managers to use the slight increase in yield to partially offset the current fee waivers in place.
  • With the Fed’s zero interest rate policy still in place, fund yields are very low and we expect them to stay relatively low over the next few years. For investors looking to invest new assets in the money market space, we favor Treasury and government money funds.

In early 2020, the “flight to quality” during the onset of the coronavirus pandemic had investors keenly focused on liquidity and potential risks in money market funds. The Fed’s actions taken during that turbulent time in the markets served to enhance liquidity in the broader markets and in money markets more specifically.

Since the onset of the pandemic, the foremost development for money market investors has been the downward trend in yields. With the Fed instituting a zero interest rate policy early in 2020, money market fund yields trended consistently lower over the course of last year and into this year. This has led some investors to wonder about the possibility of fund yields turning negative or money funds closing.

The Fed provided some relief from these concerns in June 2021 when it made upward adjustments to the interest on excess reserves and the reverse repurchase agreement (RRP). So far, these adjustments have been effective in pulling rates above the zero lower bound and in setting a floor on money market rates.

Factors affecting ultra-short-term markets

Loose financial conditions over the past year have increased liquidity, and although this has been a positive for economic growth, it has created pressures in the short-end of the curve as there has been too much cash chasing few short-term investments. At the same time, the Fed continues to create $120 billion in reserves each month due to quantitative easing, and this also has had an effect as it reduces overall available supply.

Additionally, the Treasury’s General Account (TGA) balance remains elevated, and the expectation is for the balance to come down ahead of the debt ceiling suspension expiration at the end of July. A decrease in net Treasury bill (T-bill) issuance could most likely exacerbate the supply and demand imbalance in money markets. If this persists, we expect RRP facility usage and the number of counterparties accessing the facility to continue to climb.

In our opinion, once the issue of the debt ceiling limit is resolved, the Treasury most likely will increase issuance of T-bills and short-dated securities in the fourth quarter of 2021. The Fed, on the other hand, will most likely be preparing for tapering by that time. We believe the combination of these events should provide some additional relief to the funding pressures currently experienced.

RRP facility usage increases as the TGA balance declinesRRP facility usage increases as the TGA balance declinesSources: Wells Fargo Investment Institute and Bloomberg as of July 20, 2021. Left panel chart: daily data from July 1, 2019 to July 20, 2021. Right panel chart: weekly data from July 3, 2019 to July 14, 2021. RRP = reverse repurchase (repo) agreement. TGP = Treasury’s General Account.

What it may mean for investors

The Fed’s increase in its RRP interest from 0 basis points to 5 basis points (100 basis points is equal to 1 percent) effectively increased the yields of money market securities such as U.S. Treasury and U.S. agency securities. In addition, since the latest Fed action alleviated the near-term pressure for managers to maintain a positive yield, we would also expect a lessening in the perceived need for money fund providers to close funds.

While these positive developments have certainly been welcomed by money market fund managers, we believe fund yields experienced by investors will likely remain very low for some time. We have generally observed slight increases in gross fund yields (yields before fees) for many funds, while net fund yields (yields after fees) have remained essentially unchanged at very low levels. This is primarily due to managers using the incremental yield to reduce the amount of fees they are currently waiving for investors.

Another key dynamic currently in place among money funds is the historically low incremental yield advantage that can be gained by investors moving from a Treasury or government money market fund to a prime money market fund. Given the very small yield differential and the incrementally higher level of risk associated with prime funds, we favor Treasury and government money market funds over prime money market funds for investors looking to invest new money in the money market space.

You could lose money by investing in a money market fund. Although a money market fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. A money market fund may impose a fee upon sale of your shares or may temporarily suspend your ability to sell shares if the fund's liquidity falls below required minimums because of market conditions or other factors. An investment in a money market fund is not a deposit of the bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. A money market fund’s sponsor has no legal obligation to provide financial support to the fund, and you should not expect that the sponsor will provide financial support to the fund at any time.

Risk Considerations

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve.

Money market securities are short term, highly liquid instruments, with low risk. Some of the common instruments include Treasury bills, certificates of deposit and commercial paper.

Although Treasuries are considered free from credit risk they are subject to other types of risks. These risks include interest rate risk, which may cause the underlying value of the bond to fluctuate.

U.S. government securities are backed by the full faith and credit of the federal government as to payment of principal and interest. Unlike U.S. government securities, agency securities carry the implicit guarantee of the U.S. government but are not direct obligations. Payment of principal and interest is solely the obligation of the issuer. If sold prior to maturity, both types of debt securities are subject to market risk.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

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