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As U.S. short-term rates rise, fund managers see some opportunities -Breaking


© Reuters. FILE PHOTO – Federal Reserve, Washington, U.S.A, November 22, 2021. REUTERS/Kevin Lamarque/File photo

By Karen Brettell

(Reuters) – With the Federal Reserve expected to speed up the removal of unprecedented stimulus measures, short-term rates moved higher which offered rare opportunities for money fund managers to earn yield.

Three-month commercial papers rates, which financial firms use to finance short-term cash flow, rose to 17 basis point from 11 basis points last month. Three-month Libor, which is becoming a benchmark market rate that will be phased out, has risen to 20 basis points from 13 in October. Yields on one year Treasuries are at one and a half-year highs while shorter-dated yields still remain fairly low.

The Treasury’s yields on very short-dated Treasury bills are held down due to low issuance. This is because the government maintains a low cash balance as a result the restrictions imposed by debt ceiling.

As investors and banks reduce their risk-taking for the year-end, tighter funding conditions have caused yields to some assets to go up. But rates of short-dated assets are generally higher because of the expectation that investors will price in the probability that the Fed may accelerate its reduction of bond purchases and rate hikes could begin in 2022.

“The expectation will be a much-faster taper once we calendar flip into 2022,” said Deborah Cunningham, chief investment officer for global liquidity markets at Federated Hermes (NYSE:).

Jerome Powell, Fed Chair said that U.S. central banking policymakers will consider whether to stop bond purchases several months earlier than originally anticipated. This was according to Powell’s comments at last week’s December 14-15 bank meeting.

Because there is not much high-quality investment available, money funds take advantage of some higher yields such as on commercial paper.

It is “very opportunistic. I think it’s where the market would be in Treasuries and agencies as well were it not for what is still happening from a debt ceiling standpoint,” Cunningham said.

Large part-money funds rely on the Fed’s reverse repurchase arrangement facility to get returns.

Peter Yi is director of fixed income short duration and credit research. Northern Trust Asset Management expects that demand for this facility will continue to rise in the weeks ahead. “I would say over year-end we’re going to see a pretty big pop in terms of adoption of it.”

After hitting an all-time high of $1.6 trillion in the third quarter, the demand for this facility (where money funds can loan overnight to the Fed) is at $1.5 trillion.

Yi expects that the Fed will be less aggressive in increasing rates, which may explain why Yi has seen yields rise on Treasury bills older than one year.

“We don’t think the Fed’s going to be as aggressive in raising rates as what the market is pricing today,” he said. “Whenever we see these quick jumps on some of these longer maturities like a year we’re being opportunistic, and we think those are good buying opportunities.”

One-year Treasury yields rose to 29 basis point, from 20 basis points last Thursday and 10 in September. The fed funds futures markets are pricing three rate rises for December 2022 by traders.

The increase in rates is partly due to concerns over reduced liquidity on the market, which was made more severe by the end of last year.

“There’s a lot of nervousness going around generally, which is probably why you’re seeing front-end funding rates actually drift higher,” said Gennadiy Goldberg, an interest rate strategist at TD Securities.

Cunningham stated that the removal of Libor (London Interbank Offer Rate) may have an impact on the availability of floating rate notes. These are usually based upon Libor, and could be very popular in rising rates.

“I think that represents a little bit of a risk just because funds don’t have as much in floating-rate securities and in a rising rate environment that has been a strategy that has been very successful historically,” she said.

The company will be no longer able to borrow on Libor starting at year-end. However, the rates will still be available through mid-2023.

New trades and loans will have to be made based upon the Secured Overnight Finance Rate (SOFR), which takes into account the overnight repo markets. Investors and issuers may also seek a rate that includes a spread of bank credit, although other credit indices than Libor are not gaining much popularity.