Download US Money Market Reform: The Scandi angle

Investment Research
9 August 2016
The US Money Market Reform
The Scandi angle

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.
Investors have moved out of money
market funds and into government
money market funds
Source: Bloomberg, Danske Bank Markets
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.
Important disclosures and certifications are contained from page 10 of this report.
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]
www.danskeresearch.com
The US Money Market Reform
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
Money market funds
come into effect on 14 October this year.
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)
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
https://www.sec.gov/answers/mfmmkt.
htm
https://www.sec.gov/spotlight/mone
y-market.shtml
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
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The US Money Market Reform
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
Outflow from US prime money market
funds and increasing FRA/OIS spread
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.
Source: Macrobond Financials, Danske Bank
Markets
US TED spread has widened
USD Libor at levels not seen since 2009
Source: Bloomberg, Danske Bank Markets
Source: Bloomberg, Danske Bank Markets
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.
ECB USD weekly fixed USD rates still
below 3M USD Libor
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.
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Source: Bloomberg, Danske Bank Markets
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The US Money Market Reform
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.
3M EURUSD CCS: relative credit and
liquidity
Source: Bloomberg, Danske Bank Markets
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
50
bp
0
-10
40
-20
30
bp
-30
20
-40
10
-50
Tenor
-60
3m
6m
1y
18m
2y
Current curve (08-Aug-16)
3y
4y
5y
-1m (08-Jul-16)
Source: Danske Bank Markets
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6y
7y
8y
9y
10y
-6m (08-Feb-16)
Tenor
0
1y
2y
3y
4y
5y
6y
Current (08-Aug-2016)
7y
8y
9y
10y 11y 12y 13y 14y 15y
-1m (08-Jul-16)
-6m (08-Feb-16)
Source: Danske Bank Markets
www.danskeresearch.com
The US Money Market Reform
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)
Short EUR/USD
2.5%
1.240
1.220
2.0%
1.200
1.160
1.140
1.0%
1.120
Forward level
1.180
1.5%
1.100
0.5%
1.080
1.060
0.0%
1.040
Spot
1M
2M
Nominal interest rate difference
Source: Bloomberg, Danske Bank Markets
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3M
6M
9M
Tenors
Basis spread
12M
18M
2Y
Forward level (right axis)
3Y
5Y
Annualized carry
Source: Danske Bank Markets
www.danskeresearch.com
The US Money Market Reform
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
Prime MMF Holdings of Bank Related Securities, by Country, June 2016
160 USD, billions
140
120
100
80
60
40
20
0
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.
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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
1.0%
3M Euribor swapped to SEK
3M USD Libor swapped to SEK
3m STIBOR
0.5%
0.0%
-0.5%
-1.0%
-1.5%
Jan-14
Jul-14
Feb-15
Aug-15
Mar-16
Sep-16
Source: Danske Bank Markets
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 USDdenominated 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.
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The US Money Market Reform
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
NIBOR fixing methodology
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).
NIBOR fixings are backed out from the
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.
USD/NOK FX forward via the covered
interest rate parity (CIP),
 1  i NOK
F  S
 1  iUSD


 , 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 are determined via
USD/NOK FX forwards…
…which leaves the NIBOR-policy rate
spread vulnerable to basis.
NIBOR fixings higher, cf. chart below.
Nibor fixings have risen on the back of
a higher USD ‘shortage’ premium
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…
Source: Macrobond Financial, Danske Bank
…and been remarkably immune to
higher NOK rates
Source: Macrobond, Danske Bank Markets
Norges Bank projected a tighter
NIBOR-policy rate spread in June
Source: Macrobond Financial, Danske Bank
Source: Macrobond, Danske Bank Markets
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The US Money Market Reform
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
0
NGB 4.50 22MAY2019
NGB 3.75 25MAY2021
NGB 2 24MAY2023
NGB 1.75 13MAR2025
NGB 1.50 19FEB2026
-10
-20
-30
-40
-50
-60
-70
-80
Jan-15
Apr-15
Jul-15
Oct-15
Jan-16
Apr-16
Jul-16
Source: Danske Bank Markets
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The US Money Market Reform
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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