(Bloomberg) -- The push to make money-market funds safer means the biggest U.S. banks will pay more to borrow while America’s near record-low financing costs go even lower.
Fidelity said last week that its Fidelity Cash Reserves Fund, the largest of its kind in the world, will stop buying short-term debt issued by companies in response to a regulation restricting it to U.S. government securities. The move will leave a $100 billion funding hole for lenders, such as JPMorgan and Wells Fargo who rely on the fund to buy their commercial paper and is “the opening shot” for others to follow, according to Joseph Abate, a strategist at Barclays.
“Banks will be forced to find alternative sources of funding at higher costs,” Abate said in a telephone interview. “There had been a wait-and-see approach up to this point, but the sheer size of the Fidelity fund is big enough alone to echo across market interest rates.”
Short-term borrowing costs for U.S. financial firms are already the most in two years, relative to Treasury bills, and are 46 % higher since the passing of the rule in July. That’s an increase of 7 basis points to 22 basis points. A basis point is 0.01 % point.
The plan to transfer 99.5 % of the $115.5 billion holdings in the Fidelity fund to government-backed securities would be a boon to a U.S. already benefiting from the Federal Reserve’s easy-money policies. Fidelity’s VIP Money Market Fund and its Retirement Money Market Portfolio are also taking similar actions.
The proposal by Fidelity, the Boston-based money manager, is subject to shareholder approval on May 12th. The firm expects the changes to occur in the fourth quarter.
JPMorgan and Wells Fargo are two of at least 10 banks that made up the funds holdings as of December, according to latest data from Morningstar.
Brian Marchiony, a JPMorgan spokesman and Ancel Martinez, a spokesman from Wells Fargo, declined to comment. Vincent Loporchio didn’t respond to an e-mail seeking comment.
Charles Peabody, a banking analyst at Portales Partners in New York, says the challenge for banks is limited.
“Bank’s are largely self-funding now, and you have to pay up for commercial paper, making it less attractive,” he said.
Institutional prime money funds, which invest in short-term IOUs issued by companies known as commercial paper, have to report beginning in October 2016 daily prices which may fluctuate based on their underlying holdings. Government-only funds, which investor in securities such as Treasury bills, will have fewer restrictions.
For banks domiciled outside the U.S., whose IOUs make up about $90 billion of the Fidelity fund’s holdings, the challenge will be bigger because of their inability to tap into insured deposits like their U.S. counterparts, according to Abate.
The U.S. Securities and Exchange Commission joined the Fed and the Treasury Department to buttress money market funds soon after the $62.5 billion Reserve Primary Fund collapsed in 2008 after bets it made on Lehman Brothers’s debts soured. This triggered a run on other moneyfunds and brought the $1.76 trillion market for commercial paper to a standstill.
The new regulations may worsen an already dimmed supply of short-term government securities. That should put downward pressure on rates from Treasury bills to repurchase agreements, even as the Fed is eyeing raising its benchmark rate later this year.
“This is another example of regulatory reform sweeping into the high-quality liquid market space like Treasury bills,” said Kenneth Silliman, head of U.S. short-term rates trading in New York at Toronto-Dominion Bank’s TD Securities unit. “It will have a major impact on the supply of those most liquid securities, if we see a growing trend of these conversions. This could put some pressure on rates, which are already close to zero.”
The one-month bill rate averaged 0.0183 % over the last year, trading to as low as negative 0.0101 % in January, according to data compiled by Bloomberg.
“You could start to see the flows out of prime funds to government-only intensify in 2015,” said Andrew Hollenhorst, a fixed-income strategist at Citigroup in New York. “As money flows into government-only funds, you will have more demand for government securities -- so their prices will rise.”
This would mean fewer funds that are willing to buy bank debt, according Barclays’s Abate.
Banks that rely on commercial paper have seen their borrowing cost trend higher, with the 14-day moving average of the difference between what U.S. financial institutions and the government pay to borrow for three months the most since January 2013, Bloomberg data show.
Lenders would be left to “compete more aggressively to raise the same amount of unsecured term financing from a smaller universe of potential buyers,” he said.