Article / 31 August 2016 at 14:57 GMT

Macro Digest: SEC's new rules might trigger liquidity crisis

Chief Economist & CIO / Saxo Bank
  • New regulations represent a potential liquidity risk
  • The world is short USD – a survey among Japanese banks with branches in New York shows 2/3 of their funding is raised through US based CP programs! (Hence the bid over for JPY currency swaps)
  • At a bare minimum this is USD bullish – as the “hedge” against being short US funding is to own… US dollars
 More rules. More regulations. More trouble. Picture: iStock

By Steen Jakobsen

This is very important to know and understand – there are 2.7 trillion US dollars in money market funds in the US. In the past these were mainly going to “prime funds” which invested in short-term government and commercial papers. Then came Lehman and hell broke loose.

These funds have in history guaranteed $1 net asset value always – but under Lehman it “broke the buck”….and we had liquidity crisis and a non-existent commercial paper market. Now, in order to avoid the same thing happening again, the US Securities and Exchange Commission from October 14 will allow prime funds to trade only to its NAV – (making it significantly more risky).

This means that $500 billion has left “prime funds” and gone to government funds, which as the name says can only buy government short-term papers. This has then created excess demand for T-bills and left LIBOR bid, because of course, the main difference between prime funds and government is CP papers – mainly banks and mortgage issuers – ie. $500 billion USD is “missing” in short-term funding. Hence LIBORis  bid…..a further $500bn is expected to leave before October 14, according to Morningstar.

Of course everything may go smoothly, but with a Fed wanting to hike you need to understand this “indirect” increase in not only the price of money but also the illiquidity risk. has a very informative article on what the new regulations mean for the financial system. Also, attached below is some information from Vanguard Prime Fund, the world's biggest prime fund.

JPY 1-year Basis Currency Swap (how much you will pay more for the USD relative to JPY)
Source: Bloomberg
Total Prime Funds AUM – first  time in 17 years below 1 trillion USD! 
Source: Bloomberg 

Government money market funds (MASSIVE bid for T-bills)
 Source: Bloomberg
Total amount of AUM in money market funds – 2.7 trillions US (JPM and Vanguard are the biggest players)
money mkt
 Source: Bloomberg

One-month LIBOR
 Source: Bloomberg
Two-year US generic government yield… 
govt 2-yr
 Source: Bloomberg

– Edited by Clare MacCarthy

Steen Jakobsen is chief economist and CIO at Saxo Bank


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