The Tell: Why you shouldn’t freak out about rising money-market rates


Rising short-term market interest rates aren’t a rerun of 2008.

Instead, the recent run-up, which has seen three-month dollar Libor and commercial paper rates rise by more than 20 basis points since early July, appears to be in anticipation of money-market rule changes that is starting to have some ripple effects, wrote Paul Ashworth, economist at Capital Economics, in a Wednesday note.

The collapse of Lehman Brothers Sept. 15, 2008 thrust the arcane but crucial financial plumbing of the money markets into the spotlight as banks grew reluctant to make necessary short-term loans to each other, freezing the global financial system and driving the world economy to the brink of catastrophe.

Back then, investors were glued to Libor, the London interbank offered rate, a key gauge of short-term borrowing rates, as well as the Libor spread versus overnight interest swaps as the financial system teetered before coordinated action by policy makers calmed the storm.

So, it’s no wonder that rising Libor and widening spreads raises eyebrows. But, as Ashworth notes, the latest rise looks subdued compared with what was happening in 2008 (see chart below).

Capital Economics

The situation this time around is driven by changes to Securities and Exchange Commission rules governing money-market funds that are due to take effect in mid-October. The changes are designed to prevent a repeat of the investor stampede out of money-market funds that occurred following the Lehman collapse.

Among the new requirements, shares of money-market funds that cater to institutional investors and invest in corporate or municipal debt will have to float in value, like shares for most mutual funds. That’s in contrast to the stable $1-a-share value money-market funds have traditionally maintained.

The SEC contends the transparency will allow investors to adjust their holdings in response to changes in asset values rather than streaming out of funds when they suddenly realize their shares are worth less than $1.

While only one fund “broke the buck” in 2008, the panic that ensued as investors fled other funds contributed to the drying up of money-market liquidity, Ashworth noted.

Now, liquidity is drying up “either because money-market funds are seeing redemptions ahead of the rule changes or because they want to keep more cash in hand, in case they have to meet increased redemptions in the next couple of months,” he said.

The good news is that, provided short-term rates don’t rise much more, the phenomenon is unlikely to have much impact on economic growth, Ashworth said, noting that a 20 basis point rise in short rates is modest next to this year’s 70 basis point fall in municipal bond yields and a 120 basis point decline in corporate-bond yields.

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