Brown Brothers Harriman & Co's Head of Global Markets Strategy, Marc Chandler at his Marc to Market blog:
The weighted average of the Fed funds rate has
edged higher. Following the Fed hike in December 2015, the Fed funds
average around 36 bp in January before moving into a 37-38 bp range.
However, since the UK referendum it has been trading consistently around 40
bp.
The Fed fund futures contract settles at the
average effective Fed funds rate for a given month, not at the policy rate.
Ahead of next week's FOMC meeting where practically no one expects a
change in policy, implied yield of the July Fed funds futures contract is 40.25
bp.
Some dealers think that one of the factors
that are keeping Fed funds firm is the
preparation of changes to the US money markets as of the middle of October.
Institutional money markets that invest in a range of short-term instruments
including commercial paper will be required to have a floating NAV, which is to
say that the price will not be constant at one dollar.
In addition to a floating NAV, prime funds
will be able to impose liquidity fees and redemption gates if the funds
liquidity fell below 30%. At the end of the first week in July, the
average weekly liquidity of prime funds was 53.4%. Reports indicate that
four prime funds had liquidity below 35%, but none were below 30%.
Besides these prime funds will be money market
funds that invest only in government paper. They will still have a
constant NAV, though the yield will be a
little less than the prime funds. Many institutions who use money markets
(think businesses or asset managers) will prefer the fixed NAV. Capital
preservation is more important than return for those funds.
On the surface,
it appears that there has been a huge liquidation of prime fund assets and a
move into government money markets. One set of figures
suggests that the prime funds have seen an
outflow of nearly a third of their assets, leaving about $1 trillion, as of
early July. However, a little more than half of the outflows appears to
be prime funds converting into government only funds....
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