Moody's Investors Service has revised its outlook for the money market fund (MMF) sector to negative from stable.
The change in outlook reflects the rating agency's expectation that, despite cautious investment approaches, MMFs will struggle to maintain the highest credit and stability profiles in 2015 due to an ongoing supply and demand imbalance, low to negative net yields of funds, and elevated asset flow volatility.
The report "2015 Outlook – Money Market Funds: Market Challenges Underpin Negative Outlook" is available on www.moodys.com. Subscribers can access this report via the link provided at the end of this press release.
Moody's notes that the number of MMFs rated Aaa-mf is likely to decrease in 2015. "The unstable market environment will limit fund managers' ability to offset rising risk through active management, thus making it more challenging to maintain the highest quality profiles" says Vanessa Robert, VP-Senior Credit Officer at Moody's and co-author of the report. "Furthermore, managers' commitment to maximising yields in a historic low interest rate environment may result in increasing extension of portfolios' maturities, which will put pressure on their credit and stability profiles," adds Robert.
The shortage of high quality short-term investments will drive greater risk-taking in MMFs.
"Rising investor demand for high quality short-dated investments combined with banks' deleveraging and reduced dependence on wholesale funding has resulted in much tighter supply conditions, which will push more MMFs to extend their investment tenors in pursuit of yield, and potentially move down in credit quality," says Robert Callagy, VP-Senior Analyst at Moody's and co-author of the report.
MMFs that pursue longer tenor and lower quality investments increase their susceptibility to liquidity risk, a credit negative. Moody's believes the severity of this risk has increased in the current market environment where availability of secondary market liquidity is an emerging concern due to the significant declines in broker-dealer security inventories.
The rating agency also notes that monetary policy normalisation in the US and UK, and the European Central Bank's accommodative monetary policy will likely accelerate MMF outflows. Following initial rate hikes, US and UK MMF balances will fall, as MMF yields will temporarily lag market yields on direct investments. Euro MMF assets under management levels will decline, as liquidity investors need to choose between paying for the safety and liquidity provided by a MMF, or investing in a higher yielding liquidity product with potentially weaker credit and liquidity characteristics. While funds' negative yields alone will not trigger rating downgrades, side effects of negative yields could pressure fund ratings.
Moody's expects that the new MMF regulations in the US and the proposed MMF regulations in Europe will make MMFs less attractive to institutional investors globally. Changes to product structure in the US will cause investors to significantly reduce their exposure to prime funds, and even though the implementation of the reform is not due until Q3 2016, some shifts are likely to occur already in 2015.