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Money markets sec money fund rules could roil bank loan rates

´╗┐Feb 7 The cost for banks and other borrowers to raise funds in short-term markets could jump if regulatory proposals for money market funds result in large redemptions in the industry. The Wall Street Journal on Tuesday reported that the U.S. Securities and Exchange Commission was finalizing rules to stabilize the $2.7 trillion money-market fund sector, including a requirement that funds allow their net asset values to fluctuate. The proposals are vehemently opposed by the industry, which says they will effectively kill the business."As soon as you introduce a floating NAV (net asset value), demand for the product is going to plummet," said Mary Beth Fisher, an interest rate strategist at BNP Paribas in New York. "You have no additional security by being in a money market fund."The new rules are designed to reduce risks of the large funds, which suffered an investor run after the collapse of Lehman Brothers in 2008. The run led one large fund's share value to "break the buck," which then intensified the crisis, leading to the SEC's development of the proposed rules in 2009. Fund managers contend that allowing share prices to fluctuate will remove certainty from the investments and increase, rather than reduce, the risk of a loss of investor confidence.

Money market funds provide billions in loans to banks through repurchase agreements, commercial paper and other loans. A pullback sparked by investor redemptions or from the funds simply closing down could have large market ripples. Fidelity Investments, the largest money-market fund manager, recently warned regulators that a floating NAV would result in large redemptions, "leading to unintended consequences for the financial markets and U.S. economy."Shares of Federated Investors, one of the largest money fund managers, fell 3.9 percent on Tuesday on the report. The Pittsburgh-based firm's Chief Executive Christopher Donahue told the Journal he would sue the SEC if the new rules affect Federated's ability to do business. European banks were left scrambling for dollar-based funds in the last half of 2011 as money funds withdrew loans, a large factor that led to global central banks coordinating offers of low-cost loans to banks to fill the funding gap.

Investors have pulled around $50 billion from money market funds since January 11, according to the Investment Company Institute. That in recent weeks helped increase the cost to finance overnight loans backed by Treasuries in the repurchase agreement market. The cost of overnight repo loans backed by Treasuries traded at around 10 basis points on Thursday after rising to the high 20-basis point area last week."If there are further fund redemptions, overnight funding for Treasuries will probably go back up," said Raymond Gilmartin, head of repo trading at Bank of Nova Scotia in New York.

A key question is where cash will move if money funds become less attractive. Money funds have won investors who want a guarantee that their money will be returned. Other mutual funds that invest in short-term instruments but do not guarantee the full investment return could gain at least part of the funds."There's still a huge amount of demand for short-term liquidity, people will put their money in a T-bill fund instead of a money market fund and not pay the extra fees," said BNP's Fisher. Banks, on the other hand, have been reluctant to take large deposits from investors flocking to safety as they need to pay a fee to the Federal Deposit Insurance Corp to insure the deposits. An insurance cap of $250,000 per depositor per bank is also scheduled to come into force in December."It is unclear how much of the ($1.6 trillion) institutional money held in money funds would 'go elsewhere'," Barclays Capital analyst Joseph Abate wrote in a recent report. "Banks are not eager to be on the receiving end of all this cash."

Money markets traders raise bets on more fed stimulus

´╗┐climbed on Wednesday, as traders increased their bullish bets that the Federal Reserve is prepared to provide more stimulus to counter a slowdown in the U.S. economy, exacerbated by Europe's debt crisis. Deferred Eurodollar futures rose for a fourth straight session, touching fresh contract highs. The recent slew of discouraging news on the U.S. economy, together with worrisome developments in the fiscal situation in Spain and Greece, fed expectations the U.S. central bank could soon act with more unconventional policy tools to lower interest rates in a bid to stimulate borrowing and business activities. Fed's remaining policy tools include a third round of quantitative easing in the form of large-scale bond purchases -- known as QE3 -- and lowering the interests it pays banks on excess reserves (IOER) they leave with the central bank."The market is looking for the Fed to ease at some point with a cut in the IOER and/or a full-blown QE," said Mike Lin, director of U.S. funding at TD Securities in New York. "That's supporting the move of Eurodollar futures higher."The December 2014 Eurodollar contract last traded up 1.0 basis point at 99.390 after rising to a contract high at 99.395. Eurodollar futures for 2016 to 2019 edged lower after setting contract highs earlier.

Interest rates in the dollar funding market had fallen since last week in anticipation the Fed would lower the IOER from the current 0.25 percent. Traders bet the Fed would follow the European Central Bank which almost two weeks ago dropped its rate similar to the IOER to zero in an effort to bolster the region's sagging economy. However, many analysts said the money markets in Europe and the United States are different. They said cutting the IOER would hurt the $2.5 trillion money market fund industry and risk disrupting interbank dollar lending. Still sentiment on a IOER cut was reinforced by news reports on possibly more Fed action.

"All the stories are indicating a potential chance about an IOER cut next week," TD's Lin said. Fed policy-makers are scheduled to meet for two days starting next Tuesday.

While the futures market signaled expectations of lower U.S. interest rates, overnight borrowing costs for dollars were steady to slightly higher on the day. The interest rate on overnight repurchase agreements, a key funding source for Wall Street, traded mostly at 0.22 percent, compared with 0.208 percent -- Tuesday's level on the DTCC GCF repo index level -- which is the benchmark for repo futures launched more than a week ago. Analysts said the overnight repo rate rose partly on Fannie Mae and Freddie Mac either reinvesting or disbursing to bondholders the monthly cash the two mortgage finance agencies collect from the home loans and securities in their portfolios. Benchmark three-month dollar Libor held at 0.44810 percent, its lowest level since early November. The gap between the London interbank offered rate and the overnight indexed swap rate for three-month dollars shrank 1 basis point to 30 basis points. In the derivatives market, the spread between the two-year U.S. interest swap rate and two-year Treasuries narrowed 0.5 basis point to 22.25 basis points, suggesting traders see chances of more Fed stimulus would help the banking system.