Money market fund tensions back at 2008 crisis levels, says Fitch report

Jittery investors alarmed by sovereign debt problems have been increasing their cash holding to levels not seen since the credit crisis took hold in 2008, a major Fitch study of money market  funds (MMF) has revealed.

Fitch's quarterly report on MMFs reveals that average levels of overnight and one week liquidity in euro, US dollar and sterling MMFs – which was already at very high levels – has been increasing again, 'almost reaching the levels seen during the height of the crisis in mid-2008.'

Liquidity management

The study cites less liquidity in the markets, less certainty as to where the sovereign crisis is heading, and more questions from nervous clients as the reason why 'managers now view holding additional liquidity as more prudent.'

The report states: 'In the two months from March to May 2010, the average overnight liquidity increased from 23% to 28% for euro MMFs; from 22% to 27% for sterling MMFs; and from 23% to 36% for dollar MMFs.

'The average one-week liquidity has remained stable for euro MMFs, but increased from 30% to 35% for sterling MMFs and from 34% to 42% for dollar MMFs. US dollar MMFs have experienced a decline in AUM over the past few months, and as a result, managers have built up more liquidity in these funds to meet redemptions. Liquidity is generally built through deposits, call accounts, or repos.'

Credit risk fears

Although the European Central Bank (ECB), the US Treasury and the Bank of England (BoE) have all indicated that they have no intention of hiking interest rates any time soon, MMFs have been reluctant to take any exposure to interest rate risk and have not extended maturity, as one would expect.

The report explains: 'Despite the consensus view that interest rates will remain on hold in the short term, most funds are not taking this opportunity to position themselves longer on the curve, due to the uncertain market environment and growing concerns over some European sovereigns.

'[The traditional measure of a MMF’s exposure to interest rate risk] across all currencies fell notably from March this year, as managers deemed the risk-return trade-off unattractive and chose instead to build liquidity and manage credit risk.

'Although there is no expectation of a greater jump to default by the bigger and more highly rated banks – which typically comprise a large portion of MMF portfolios – there is a considerable amount of headline risk, marked-to-market risk, and liquidity risk that is keeping managers cautious.'

Yield dilemma