Sunday, April 1, 2012

Eurozone money market funds, a melting ice cube

The ECB's LTRO program accomplished much in terms of reducing liquidity risk in the Eurozone's financial sector. But as is often the case with government interventions, it created numerous "unintended consequences". One of those effects is a massive reduction in the availability of short-term non-government paper. This paper has been taken out of the market for two reasons:

1. With attractive term financing from the ECB, there is far less need to issue euro denominated commercial paper or short-term notes.

2. A great deal of short-term paper that has been issued is trapped at the ECB (more precisely the NCBs) as collateral and is not coming out any time soon.

This is creating difficulties for euro denominated money market funds. As an example, below is a chart for the JPMorgan Luxembourg formed euro money market fund (ticker symbol JPMELRF LX). It has become difficult for the firm to retain investors because the return on this fund has literally flat-lined.

 JPMELRF LX total return (Bloomberg)
Description: JPMorgan Funds Euro Market Fund is an open-end SICAV incorporated in Luxembourg. The Fund's objective is to achieve a competitive total return. The Fund invests all of its assets, excluding cash and deposits, in high transferable debt securities and/or bonds of which at least 75% will be denominated in Euro.
Needless to say JPMorgan is not happy about that.
Reuters: "The LTROs are a double-edged sword," said John Donohue, chief investment officer for J.P. Morgan Asset Management Global Liquidity. "They calmed everybody down and took the liquidity tail risk off the table for money funds. But there is less supply now for us to get invested."

Ultimately this may mean banks, companies, and governments will need less short-term funding, a so-called crowding out effect. That could result in fewer investment opportunities for money market funds, which generally prefer taxable investments thanks to their higher yields.
Near zero (or sometimes zero) rates combined with the uncertainties around the money market product are sending Eurozone investors out of the product. The total euro denominated money market balances have declined sharply in recent months.

Total Eurosystem money market funds holdings (EUR MM, Source: the ECB)

It is unclear if there is a future for this product in the Eurozone. It may take the unwind of the LTRO program some three years down the road and the normalization of short-term issuance before the business becomes profitable again. For now some firms will run it purely as a loss leader for their asset management clients with hopes of recouping revenues elsewhere.
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