Money Market Perspective - Could, one day, short term rates become positive?
Accommodative monetary policy
For many years now, the European Central Bank (ECB) has been conducting a very accommodative monetary policy. By combining different non-conventional measures, namely the Asset Purchase Program (€30Bn per month), the Very Long Term refinancing Operations, the negative Deposit Rate (-0.40%) and the forward guidance on interest rates, the ECB has been able to anchor short term rates in negative territory and to ensure very favorable financing conditions for both firms and households in the euro area. While this very supportive environment has been a key contributor to the firming of the economic recovery in Europe, it has raised questions about the sustainability of the money market industry.
"Money market funds still
represent the best cash management solution." - Mikaël Pacot, Head of Money Markets
at AXA Investment Managers
Sustainability of the money market industry?
Admittedly, with money market rates fixing at very negative levels (Eonia around -0.36%, 3-month Euribor at
-0.33%) and with the full investment universe offering negative yields, euro denominated money market funds have delivered negative performances (in the -0.20% / -0.30% area for 2017). It is fair to say that 2017 has been the worst interest rate environment ever for euro denominated money market funds. Nevertheless, as counterintuitive as it may seem, these funds recorded an increase in assets under management last year. Amazingly, this upward trend started at the end of 2014, the year when the Eonia fixing turned structurally nega- tive ! Despite negative returns, investors have not been deterred from investing in money market funds.
Performance is definitely not the only element at stake when investors decide where to place their cash. If banks, thanks to their status, have access to the ECB Deposit Facility at -0.40%, this is not the case for other investors. They need to find a way to “park” their cash, be it via short term bills, reverse-repo operations, bank deposits, commercial papers or money market funds. Thus, for most institutional investors, the rate offered by the Deposit facility is not a floor and money market funds still represent for them the best cash management solution. Not only do they offer a rather competitive return (at least in relative terms), but also a high level of liquidity and risk reduction through portfolio diversification, while allowing for same-day cash settlement.
We do not expect the money market context to change dramatically in the first part of 2018 but things could start to improve soon. The latest data suggest that the economic activity has gathered momentum in the euro area. Growth is becoming increasingly self-sustaining thanks to solid job creations, favorable financing conditions,
declining political uncertainty and an increasingly synchronized global recovery. So far inflation pressures have remained subdued and have yet to show convincing signs of a sustained upward trend. However, the ECB is becoming increasingly confident that the stronger than expected economic expansion will contribute to a gradual convergence of inflation to levels below, but close to, 2% over the medium term. As such, the ECB communication will have to evolve gradually and, with QE approaching its end (September or December 2018), the focus will progressively shift to the rates level. We expect the ECB to tweak the current forward guidance in March, at the earliest, and to clarify the end date of QE in June. A first rate hike could happen around Q2 2019. While the very short end of the money market curve should stay anchored in negative territory for most of 2018, the longer end could begin to steepen. This move would come as a great relief to most of us !