Investment Research The US Money Market Reformdanskeresearch.danskebank.com/abo/USMMReform090816/$file/...Investment Research Over the summer, we have seen a pronounced rise in USD

Important disclosures and certifications are contained from page 10 of this report. www.danskeresearch.com

Investment Research

Over the summer, we have seen a pronounced rise in USD Libor rates, FRA-OIS spreads,

EUR/USD CCS basis and TED spreads have all widened. The main culprit is the US money

market reform (MMR) and the new regulatory requirements that will come into effect on 14

October this year. The MMR reform has resulted in large flows in the US money market,

where assets of more than USD500bn have left prime money market funds that will have to

adopt the new requirements and into government money market funds that are exempt.

We ask the question, when will we find a new equilibrium in the market that can put a brake

on the relentless rise in USD Libor fixings? We argue:

The higher rates in the money and the CP market should start to attract new investors.

For eurozone banks, we are now approaching a level where it may soon be cheaper to

get USD funding through the ECB USD facility than in the market.

Finally, it seems that many banks have accepted a shorter maturity on their funding,

though it might collide with other regulatory incentives, especially LCR.

However, it is probably too early to call an end to the move higher in USD Libor fixings and

spillover to other markets as long as the outflow from prime money market funds continues.

But the speed should, in our view, moderate now as we have already seen a USD500bn flow

out of a stock of around USD1,500bn.

The Scandi angle

In Sweden, the net effect from the US MMR has been a downward pressure on Stibor

fixings.

The US MMR has dented demand for USD CPs issued by Swedish banks and banks’ need

for USD funding seem instead to have been met through the USDSEK FX forward market

indirectly pushing Stibor fixings lower.

In Norway, money market rates have risen on the back of NIBOR fixings’ connection to

USD/NOK FX forwards and tight NOK liquidity.

The higher NIBOR-policy rate spread is an implicit monetary tightening in Norway that

Norges Bank historically has referred to when cutting rates. In isolation, the US MM-reform

thereby supports our call for additional rate cuts. The higher NIBOR fixings have meant that

ASW-spreads for shorter-dated NGBs have widened significantly relative to longer-dated

NGBs. If the USD Libor continues to rise, then this will add to the ASW-spread widening.

The impact on the Danish market is mainly seen in the USDDKK FX forward, whereas there

is no effect to be seen on CIBOR fixings.

In general, the moves in the USD/NOK and USD/SEK FX forward and USDSEK and

USDNOK CCS basis make it attractive for investors to buy short-dated DKK and SEK

government papers and swap them into USD for an extra pick-up relative to US T-bills. The

high NIBOR fixings mean it is not attractive to swap NOK T-bills into USD despite the

positive NOK T-bill yield.

9 August 2016

Chief Analyst, Head of Fixed Income Research Arne Lohmann Rasmussen +45 4512 85 32 [email protected]

Senior Analyst Carl Milton +46 (0)8-567 80698 [email protected]

Analyst Kristoffer Kjær Lomholt +45 4512 8529 [email protected]

Analyst Mathias Røn Mogensen +45 4514 7226 [email protected]

The US Money Market Reform

The Scandi angle

Investors have moved out of money

market funds and into government

money market funds

Source: Bloomberg, Danske Bank Markets

mailto:[email protected]

2 | 9 August 2016 www.danskeresearch.com

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The Money Market Reform

The US money market reform (MMR) was decided on in 2014 and came as a response to the

collapse of the Reserve Primary Fund in 2008. The reform was adopted in July 2014 and will

come into effect on 14 October this year.

The most controversial part of the reform is the rules for NAV and the liquidity fees and

redemption gates:

NAV: The MMR introduces a floating net asset value (NAV) for sales and redemptions

based on the current market value of the securities in the portfolio. Historically, focus has

been on the ability to preserve the value of investments at USD1 a share. Hence, the risk has

increased, all else equal, that a fund will ‘break the buck’. (NAV going below USD1).

Liquidity Fees and Redemption Gates: Will provide new tools to money market funds to

address a potential run on a fund. The new tool tools will give funds the ability to impose

liquidity fees or to suspend redemptions. They will be enacted if a fund’s level of ‘weekly

liquid assets’ falls below a certain threshold.

Hence, investors in money market funds are now facing liquidity and redemption risks from 14

October and onwards. Given that money market funds are often used as liquidity instruments

and conceived as low risk by investors, the new rules have not been welcomed. Importantly,

government money market funds would not be subject to the new fees and gates provisions.

Therefore, we are currently witnessing an outflow from prime money market funds, where the

new rules will be effective, to government money market funds that are exempt. Furthermore,

the rules of when a fund can be labelled Government money market funds have been tightened.

A fund would only be defined as such if it invests 99.5 percent (formerly 80 percent) or more of

its total assets in cash, government securities and/or repurchase agreements that are

collateralised solely by government securities or cash.

Consequences of the MMR

The move we have seen out of US prime money market funds this year has been very

comprehensive, with close to USD500bn leaving this type of money market funds. Importantly,

the move out of money market reforms has accelerated over the last couple of months, especially

as 3M papers now extend over the 14 October MMR date. Assets have instead moved to

government money market funds exempt from the controversial parts of the reform.

Shift of assets in the US money market

Source: Macrobond Financial

Money market funds

A money market fund is a type of

fund typically investing in short-term

securities, such as government

securities, certificates of deposit and

commercial papers. There are

several types of money market funds,

e.g. funds investing primarily in

government securities or corporate

debt securities. Money market funds

that primarily invest in corporate

debt securities are referred to as

prime funds. (Source: US Securities

and Exchange Commission)

https://www.sec.gov/answers/mfmmkt.

htm

https://www.sec.gov/spotlight/mone

y-market.shtml

https://www.sec.gov/answers/mfmmkt.htm

https://www.sec.gov/answers/mfmmkt.htm

https://www.sec.gov/spotlight/money-market.shtml

https://www.sec.gov/spotlight/money-market.shtml


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This move has had some notable consequences. USD liquidity has become less abundant and

we have seen a significant move higher in USD Libor rates. The effect has been more

pronounced in longer tenors and USD Libor fixings continue to set new highs and we are at

levels not seen since 2009. Furthermore, the move higher in USD Libor rates has accelerated

over the summer. The move indirectly works as a tightening of US monetary policy.

The move out of prime money market funds and the move higher in USD Libor rates have come

through a widening of the FRA-OIS spread as seen in the graph to the right. The move out of

prime money market funds has also affected the Commercial Paper (CP) market. The demand

for CP has dropped as assets have been moved out of the prime money market funds. Hence, the

USD funding costs for e.g. European banks using USD CPs have gone up.

The US TED spread (difference between USD Libor – 3M generic US T-bill yield) has also

moved higher in 2016 compared to 2015 as assets have moved into government money market

funds, depressing the yield on US T-bills relative to the USD Libor. Note that the move in the

TED spread is mainly a move higher in USD Libor, whereas the 3M T-bill level has been more

or less stable.

USD Libor at levels not seen since 2009


When will a new equilibrium be found?

The big question now is when we will find a new equilibrium in the market that can put a brake

on the relentless rise in USD Libor fixings and stop the spill-overs and feedback mechanisms to

and from other markets such as CCS basis, FX forwards, CP market, etc.

First of all, the higher rates in the money and the CP market should start to attract new investors.

Some of the ‘old investors’ in short-dated government bonds will probably start to switch into

the higher-yielding money market products, including the CP market. It could be everything

from retail investors, corporate clients with excess cash or foreign accounts with USD assets.

But in that respect note that we have a ‘hump’ of CP programmes maturing ahead of the 14

October deadline, as the cost for issuing CPs with a maturity beyond the 14 October deadline

has been high for a long time.

Outflow from US prime money market

funds and increasing FRA/OIS spread

Source: Macrobond Financials, Danske Bank

Markets

US TED spread has widened


ECB USD weekly fixed USD rates still

below 3M USD Libor



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Secondly, especially for foreign banks including eurozone banks, we are now approaching a

level where it may soon be cheaper to get funding through ECB utilising the USD swap lines

that were established in the wake of the financial crisis. However, the use of these liquidity

facilities are probably still attached with some kind of stigma and it is also lending against

collateral. Furthermore, it is a weekly USD facility that the ECB is offering. Hence, this can

create other issues especially in a LCR (Liquidity Coverage Ratio) world. The rate on the latest

USD tender operation from the ECB was a weekly fixed rate of 0.90%, close to the current 3M

USD Libor rate of 0.79%, but still well above the 0.50% 1M USD Libor rate.

Finally, it seems that many banks have accepted a shorter maturity on their funding. But of

course such a strategy again can collide with other regulatory incentives, especially LCR

requirements. Furthermore, it is important to remember that the ‘amount’ of USD liquidity in

the US market is unchanged. It is the preference for placing USD in different assets that has

changed. One consequence being that USD liquidity is flowing less ‘frictionless’ to Europe

through, for instance, CPs.

All in all, it is probably too early to call an end to the move higher in USD Libor fixings and

spill-over to other markets as long as the outflow from prime money market funds continues.

But the speed should, in our view, moderate now as we already see a USD500bn flow out of a

stock of around USD1,500bn. The amount of CPs maturing ahead of the 14 October deadline is

a clear risk factor here.

In respect of the outright level, the recent move higher also has an effect on US monetary policy

and makes a September rate hike even more unlikely despite the latest strong labour market

report. If 3M USD Libor moves another 10bp higher, it will basically mirror a 25bp hike in the

Fed Funds rate.

FX forwards and CCS market

The big flows in the US money market and the issues with CP programmes have also affected

the cross currency basis (CCS) market, where USD has become more expensive against EUR.

It reflects that an alternative to e.g. an USD CP programme is to ‘create’ USD using the FX

forward or CCS market.

The 3M EURUSD CCS has declined as the relative liquidity component (Eonia/OIS CCS basis)

has weighed more on the 3M EURUSD CCS than the opposite drag from the relative credit

component (FRA/OIS - FRA/Eonia). Hence, the liquidity preference (USD shortage) has

outweighed the increase in the USD 3M relative to 3M EUR. Note that we have seen no effect

on Euribor from the higher USD Libor.

The front-end of the USD FRA/OIS spread curve has increased substantially, in particular in the

front–end and to some extent in the belly, while the move has been more muted in longer tenors.

EURUSD CCS spot curves

USD FRA/OIS spread curves

Source: Danske Bank Markets


-60

-50

-40

-30

-20

-10

0

3m 6m 1y 18m 2y 3y 4y 5y 6y 7y 8y 9y 10y

bp

Tenor

Current curve (08-Aug-16) -1m (08-Jul-16) -6m (08-Feb-16)

0

10

20

30

40

50

1y 2y 3y 4y 5y 6y 7y 8y 9y 10y 11y 12y 13y 14y 15y

bp

Current (08-Aug-2016) -1m (08-Jul-16) -6m (08-Feb-16)

Tenor

3M EURUSD CCS: relative credit and

liquidity



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This pattern is also reflected in the USD ASW curve (3M). Hence, the recent move in the US

ASW curve seems to have been driven mainly by the change in the USD FRA/OIS spread curve.

The move of assets into government money market funds seems to have depressed the yield on

US T-bills, with some spill-over to also shorter (sub 5Y) US Treasury yields. This is reflected

by moves in the US ASW OIS curve that has widened (become less negative) more in the 2y

compared to the 10y US ASW OIS.

US 2Y ASW 3M: FRA/OIS and ASW

OIS

US 10Y ASW 3M: FRA/OIS and ASW

OIS

Source: Danske Bank Markets, Bloomberg

Source: Danske Bank Markets, Bloomberg

In the FX forward market, we have seen as a consequence of the changes in the CCS basis and

the higher USD Libor some significant moves in EUR/USD FX forwards, and it has become

increasingly expensive to ‘create’ USD in the FX forward market.

That said it is difficult to say whether it is the higher USD Libor fixings that have an effect on

the EURUSD FX forwards or vice versa. The causality is not always clear.

Expensive to create USD in FX forward

market

Basis explains a large part of

expensive USD in the FX forward

market (EUR/USD FX forward

decomposed into basis and OIS spread

on different tenors)



1.040

1.060

1.080

1.100

1.120

1.140

1.160

1.180

1.200

1.220

1.240

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Spot 1M 2M 3M 6M 9M 12M 18M 2Y 3Y 5Y

Fo

rw

ar

d l

ev

el

Tenors

Short EUR/USD

Nominal interest rate difference Basis spread Forward level (right axis) Annualized carry


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Sweden – downward pressure on

Stibor

In Sweden, the net effect from the U.S. money market framework changes has meant downward

pressure on fixings, with front-end Ted spreads (FRA vs Riba) trading in clear negative territory

(-4bp for FRA DEC16 vs Riba Mar17). We see this very unusual situation as driven by price

action in USDSEK FX forwards. More on that below.

Big move USDSEK FX forwards, pips

Source: Macrobond financials

If we take a step back, Swedish banks have historically been large issuers of USD-denominated

CPs and have no doubt been impacted by the upcoming regulatory changes. One reason for the

significant issuance of USD denominated papers is the structural demand from SEK-based

investors for USD funding. Several large domestic pension funds hold significant amounts of

foreign assets, but have wanted to avoid the outright FX exposure. This has created a large

aggregate USD funding need, generally met though banking counterparts. This is nothing new

and has been highlighted as a risk factor by the Riksbank on numerous occasions (see for

instance:http://www.riksbank.se/Documents/Rapporter/FSR/2013/FSR_1/rap_fsr1_130527_en

g.pdf from page 52).

Sizeable USD CP programmes by Swedish banks

Source: SEC

However, in conjunction with the new U.S. rules, demand for USD CPs issued by Swedish banks

has fallen, and banks’ need for USD funding seems instead to have been met through the

USDSEK FX forward market. Despite a gradual rise in the 3M USD Libor fixing, when swapped

to SEK 3M USD Libor it has implied a lower 3M Stibor fixing.

0

20

40

60

80

100

120

140

160 USD, billions

Prime MMF Holdings of Bank Related Securities, by Country, June 2016

http://www.riksbank.se/Documents/Rapporter/FSR/2013/FSR_1/rap_fsr1_130527_eng.pdf%20from%20page%2052

http://www.riksbank.se/Documents/Rapporter/FSR/2013/FSR_1/rap_fsr1_130527_eng.pdf%20from%20page%2052


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The chart below shows how 3M Stibor compares to 3M Euribor and 3M USD Libor swapped to

SEK using the FX forward market. As can be seen, historically the relationship has been fairly

strong between 3M Euribor swapped to SEK and 3M Stibor. For a long time, swapped 3M USD

Libor has pointed towards lower 3M Stibor fixings, but this has accelerated during the summer.

Downward pressure on STIBOR


The more explicit framework by the Swedish Bankers’ Association implemented in 2012

(http://www.swedishbankers.se/Documents/Stibor/Ramverket%20del%202%20och%203%20

EN%20%204_0%20febr%202016%20.pdf) includes a reference to USD funding swapped to

SEK. It is obviously this component that has been a significant in driving Stibor fixings lower.

One could argue, however, that the composition of banks’ funding has shifted as the access to

the USD CP market is significantly more difficult, meaning that the share of USD CP funding

should have decreased. Or the low implied Stibor fixings from swapped USD Libor may simply

reflect the fact that price movements in FX forwards have moved much faster than the stickier

USD Libor fixing. In that case, the negative Ted spreads observed may simply be an overreaction

that may settle over time.

Continued volatility and Stibor below Riksbank repo rate for now

On a longer horizon, it will be of significant importance what happens with demand for USD-

denominated CPs issued by Swedish banks. Swedish banks clearly remain among the most solid

European banks and are therefore well placed once the uncertainty regarding the new regulations

decreases. In such a scenario, Ted spreads should quickly normalise towards positive levels

(albeit low levels, given the large excess of SEK liquidity accumulated after Riksbank QE).

However, we could see continued volatility before the regulations are in place. Thus, 3M Stibor

below the current Riksbank repo rate could remain a lasting feature over the next months.

So far, partly because it is a new development, there has been little discussion regarding the

negative fixing spreads outside financial markets. From a Riksbank perspective, a smaller

deviation in Stibor will probably not attract much attention. Rather, potential implications for

longer-term financial stability may come into more focus if demand for CP issued by European

banks in USD does not recover in coming months.

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

Jan-14 Jul-14 Feb-15 Aug-15 Mar-16 Sep-16

3M Euribor swapped to SEK 3M USD Libor swapped to SEK

3m STIBOR


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Higher NIBOR fixings in Norway

In Norway, the benchmark NIBOR rate fixings are based on FX forwards as specified by the

rules laid down by Finance Norway. Specifically, a panel of six banks report daily fixings

backed out from USD/NOK FX forwards using individually estimated costs of borrowing

unsecured USD in the interbank market (for more info see box to the right and Additional

Guidelines for panel banks’ Nibor submissions).

In practice, this has the important implication that NIBOR fixings are not only influenced by

domestic monetary policy expectations, but also by international conditions even if this is

not expected to influence the domestic interbank market. As the chart below-left shows, NIBOR

rose during the European debt crisis as a result of eurozone money market stress. Over the last

few years, the NIBOR-policy rate spread has again risen as a result of first ECB QE and now

the US money market reform both widening the relative USD-shortage premium in combination

with relatively tight NOK money market liquidity, cf. mid chart below.

NIBOR fixings are determined via

USD/NOK FX forwards…

…which leaves the NIBOR-policy rate

spread vulnerable to basis.

Source: Macrobond Financial, Danske Bank Source: Macrobond Financial, Danske Bank

The higher NIBOR fixings result in an unwanted de facto monetary tightening in Norway.

Indeed, the NIBOR-policy rate spread is one of the most cited factors in Norges Bank’s

monetary policy for a lower rate path. In June, Norges Bank implicitly assumed that the 3M

NIBOR-policy rate spread would fall back to an average of 28bp in Q3 - i.e. a much tighter

spread than now – whilst at the same time signalling a 100% probability of a 25bp rate cut in

September under a ‘Bremain’ scenario. In isolation, the money market reform in the US

therefore supports our call for a September rate cut – a call strengthened by the drop in the oil

price, lower global rates and Brexit-related uncertainties. In this respect, it is important that the

import-weighted NOK only is modestly weaker than NB assumed in June (c. 0.6%), which is

not enough to prevent a cut. Also, it is noteworthy how the NOK has followed the oil price

development closely while it has stayed fairly immune to higher NOK rates.

The NOK has followed oil closely…

…and been remarkably immune to

higher NOK rates

Source: Macrobond Financial, Danske Bank Source: Macrobond Financial, Danske Bank

NIBOR fixing methodology

NIBOR fixings are backed out from the

USD/NOK FX forward via the covered

interest rate parity (CIP),

USD

NOK

i

iSF

1

1, such that: NIBOR = FX

Forward (in %) + ‘USD rate’

As Norges Bank aims at keeping reserves

within a fixed interval, the relatively tight

NOK liquidity means that a wider US

FRA/OIS spread will have a tendency to push

NIBOR fixings higher, cf. chart below.

Nibor fixings have risen on the back of

a higher USD ‘shortage’ premium

Source: Macrobond, Danske Bank Markets

Norges Bank projected a tighter

NIBOR-policy rate spread in June

Source: Macrobond, Danske Bank Markets

https://www.finansnorge.no/globalassets/nibor-og-nowa-mm/nibor-rules/additional-guidelines-for-panel-banks-nibor-submissions.pdf

https://www.finansnorge.no/globalassets/nibor-og-nowa-mm/nibor-rules/additional-guidelines-for-panel-banks-nibor-submissions.pdf


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The higher NIBOR fixings have started to have an impact also on the Norwegian swap curve as

market participants start to see this as being a more permanent feature of the US money market

and henceforth NIBOR fixings. Most notable has been a recent widening for short NGB asset

swap spreads as seen in the chart below.

Norwegian asset swap spreads have widened


-80

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-30

-20

-10

0

Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16

NGB 4.50 22MAY2019 NGB 3.75 25MAY2021

NGB 2 24MAY2023 NGB 1.75 13MAR2025

NGB 1.50 19FEB2026


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Disclosures This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S (‘Danske Bank’). The

authors of the research report are Arne Lohmann Rasmussen, Chief Analyst, Head of Fixed Income Research, Carl Milton,

Senior Analyst, Kristoffer Kjær Lomholt, Analyst, and Mathias Røn Mogensen, Analyst.

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