Portfolio Manager Commentary
Download PDF
Overview, strategy, and outlook: as of May 31, 2013
Contributing authorsDavid D. Sylvester, Head of Money Funds, Senior Fund Manager
612-667-5107 | david.d.sylvester@wellscap.com
Laurie R. White, Managing Director and Senior Fund Manager, Taxable Money Funds
612-667-4275 | laurie.r.white@wellscap.com
Michael C. Bird, Senior Fund Manager, Taxable Money Funds
612-667-6529 | michael.c.bird@wellscap.com
Madeleine M. Gish, Senior Fund Manager, Taxable Money Funds
415-396-2668 | madeleine.gish@wellscap.com
John R. Kelly, Fund Manager, Taxable Money Funds
612-667-2045 | kellyjr@wellscap.com
James C. Randazzo, Senior Fund Manager, Municipal Money Markets
704-374-3086 | jrandazzo@wellscap.com
Daniel J. Tronstad, Senior Fund Manager, Taxable Money Funds
612-667-7647 | daniel.j.tronstad@wellscap.com
Michael W. Shinners, Senior Investment Research Analyst
612-667-5523 | michael.w.shinners@wellscap.com
Money market overview
On June 3, one of the most significant recommendations to reform the London Interbank Offered Rate (LIBOR) will take effect. Last fall, in his review of LIBOR following investigations into the rate-setting process, Martin Wheatley, managing director of the Financial Services Authority and chief executive-designate of the Financial Conduct Authority recommended that "LIBOR submissions should be explicitly and transparently supported by transaction data" and should no longer be compiled or published "for those currencies and tenors for which there is insufficient trade data." As a direct result of these recommendations, the British Bankers’ Association will cease publication of rates for the following periods: 2 weeks, 4 months, 5 months, 7 months, 8 months, 10 months, and 11 months after May 31, 2013.
This should have little direct market effect on short-term markets considering the fact that little trading activity in these periods is what prompted the change. Still, investors do encounter some securities with those tenors, albeit infrequently, and may want some sort of rate to benchmark against.
Last July, we discussed the mounting LIBOR controversy and some possible alternatives to use as a benchmark. One alternative we discussed was Eurodollar futures contracts, traded on the Chicago Mercantile Exchange, which could be used to calculate a Eurodollar synthetic forward (EDSF) from the rates implied by the futures contract prices. Eurodollar futures measure the market’s collective view of where three-month LIBOR will be fixed at the contracts’ expiration dates and have the advantage of being an intraday rate based on real transactions—albeit derivative transactions—rather than being set once a day like LIBOR. In addition, it is familiar to many market participants, considering prior to the onset of the financial crisis EDSF was commonly used in trading term fixed-rate money market instruments.
The next change to the LIBOR regime will come at the end of this month when the publication of submissions by individual LIBOR panel members will be delayed for three months. We would view this as a net positive, as it removes the incentive for individual panelists to understate their borrowing costs in times of individual or market distress. It should not really have an impact on the LIBOR because panelists are already required to justify their posting to regulators.
Rates for sample investment instruments
Current month-end % (May 2013)
| Sector | 1 day | 1 week | 1 month | 3 month | 6 month | 12 month |
|---|---|---|---|---|---|---|
| U.S. Treasury repurchase agreements (repos) | 0.06 | 0.07 | 0.07 | 0.07 | – | – |
| U.S. Treasury bills | – | – | 0.01 | 0.03 | 0.06 | 0.13 |
| Agency discount notes | 0.01 | 0.01 | 0.02 | 0.04 | 0.08 | 0.14 |
| LIBOR | 0.13 | 0.16 | 0.19 | 0.28 | 0.41 | 0.69 |
| Asset-backed commercial paper–First Tier | – | 0.18 | 0.21 | 0.27 | – | – |
| Dealer commercial paper–First Tier | – | 0.13 | 0.16 | 0.22 | – | – |
| Municipals–First Tier | 0.09 | 0.12 | 0.15 | 0.15 | 0.17 | 0.20 |
Source: Bloomberg, L.P.
Past performance is no guarantee of future results.
Sector views
Prime sector
The Federal Open Market Committee’s (Committee’s) May 1 policy statement contained a surprise for market participants:
"The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes."
Combined with comments by Federal Reserve (Fed) Chairman Ben Bernanke and other Committee members, the Fed’s announcement that it could consider decreasing purchases of U.S. Treasury and mortgage-backed securities if economic indicators continue to improve caused a fairly dramatic sell-off in the bond market. While tapering is nowhere close to tightening, the phrasing, including the potential time frame of "over the coming months," caused the bond market to sell off and the Treasury curve to make a sizable upward shift. The yield of the U.S. Treasury 10-year notes increased by 45 basis points (bps; 100 bps equals 1.00%) during May; a jump of that magnitude hasn’t been seen since the fourth quarter of 2010.
U.S. Treasury yield curve 3 months vs. 10 years
Source: Bloomberg, L.P.
Past performance is no guarantee of future results.
In addition to the Treasury curve steepening, credit spreads throughout the curve, as well as volatility, also increased. In fact, while the Dow Jones Industrial Average is up roughly 16% year to date, investment-grade corporate, Treasury, and aggregate bond total returns moved into negative territory on a year-to-date basis, according to Barclays’ indexes.
The front end of the yield curve, however, has decoupled from the rest of the curve, with short rates exhibiting nothing resembling a jump or credit spread widening. In fact, with repurchase (repo) rates plummeting to the low single digits for a large part of the month, demand for other short-term securities drove term yields down yet again. Australian and Canadian issuers continued to gather assets four months and longer, with floating-rate notes of six-month to one-year final maturities being most in favor. This increased demand can be observed by the continued flattening of the LIBOR curve (below).
LIBOR yield curve (%)
Source: Bloomberg, L.P.
Past performance is no guarantee of future results.
According to Crane Data, prime money market fund assets increased more than $6 billion in May. And while the commercial paper statistics from the Fed show an increase in outstanding paper for May, the majority of that was in the nonfinancial sector, with issuers taking advantage of the low short-term rates to borrow money to fund share buybacks. Financial paper outstanding was flat in May and the asset-backed commercial paper sector saw continuing contraction; so, once again, we had more assets chasing fewer investment choices. In light of this continued flattening of the money market curve, we still favor maintaining a high degree of liquidity, concentrating in high-quality investments, and modestly extending duration to capture incremental yield.
U.S. government sector
We’ve seen it coming for a while now. That light at the end of the tunnel was a train after all, and it’s finally here, rolling over the money markets with ultra-low rates. The Depository Trust and Clearing Corporation (DTCC) Treasury repo rate touched a 17-month low of 1.6 bps on May 29, 2013; the average for the month was 8.5 bps, almost half the 15.6 bps average for the first four months of the year and down even more from the 2012 average of 21 bps.
The near-term culprit was a seasonal decline in U.S. Treasury bill (T-bill) issuance of nearly $200 billion since April 15, which pressured the entire government sector lower. The acute shortage of T-bills pushed yields on T-bills with maturities of up to two months down to zero at times, and as mentioned above, repo yields suffered as well.
In a larger context, though, this move has its origins in dual Fed decisions in late 2012 to stop Operation Twist at the end of that year and simultaneously expand its security purchases via its Quantitative Easing (QE3) program. As you will recall, Operation Twist included Fed sales of some of the shorter-dated Treasury securities in its portfolio, which caused a buildup of those securities on dealer balance sheets, increasing the supply of repo collateral and, in turn, driving repo rates higher. Twist’s end meant the end of the boost to repo rates that investors had enjoyed for most of 2012. QE3, on the other hand, sees the Fed buy a combined $85 billion of Treasury and mortgage-backed securities each month, regularly draining collateral from the system and tucking it away, out of reach of the repo market.
Those 2012 decisions made it clear that 2013 was likely to be difficult for short-term investors in government securities. The tax season bump in T-bill issuance that comes along in the first quarter of each year helped soften the blow for a while, but as it faded, the full effect of the Fed’s actions became apparent. As seen in the chart on this page, as net dealer positioning goes, so go repo rates, with the relationship particularly evident for the past seven months or so. It’s worth noting that as dealer inventories rose in the spring, repo rates merely stabilized, bouncing slightly before plunging as inventories fell in May. This likely reflects the cumulative effect of the Fed’s ongoing security purchases.
Primary dealer net government securities position (millions) and repo rates
Sources: Federal Reserve Bank of New York; Bloomberg, L.P.; Wells Capital Management
Past performance is no guarantee of future results.
Given that the Fed intends to continue buying indefinitely, the near-term outlook for government rates in the money market space seems grim. Even if the Fed were to reduce its purchase amounts later in the year, continued purchases represent a persistent drain of collateral. Looking a bit further out, though, it’s possible that the light dimly seen is actually the end of the tunnel and not another train. Short-end rates will likely be led higher only after the long-end moves, and May saw the first signs that the long end of the Treasury market sees higher rates ahead. If past behavior can shed light on the future, when that move happens in earnest, eventually the Fed will taper the amount of its purchases, then stop altogether, and then finally raise short-term rates in one way or another.
Municipal sector
Yields in the short end of the municipal money market space slowly began to return to their pre-April 15 tax season levels, as outflows from tax-exempt funds moderated and demand from nontraditional crossover investors intensified during the latter half of the month. Variable-rate demand notes (VRDNs) and tender option bonds (TOBs) with daily and weekly puts became increasingly attractive alternatives to taxable instruments, as repo rates experienced a steady decline due to a continued drop in supply of T-bills. With little new-issue tax-exempt supply to speak of, it didn’t take long for dealers’ inventory levels to dry up, exerting some downward pressure on rates later in the month.
The pressure on rates was particularly strong in the overnight space where yields on top-tier VRDNs and TOBs fell in harmony with repo rates, from roughly 0.19% to 0.09% by the end of the month. In the weekly market, the Securities Industry and Financial Markets Association (SIFMA) Municipal SWAP Index1 continued its slow descent from its one-year high set on April 17. After starting the month at 0.22%, the index eventually settled in at 0.12% by month-end as dealers anticipated the heavy coupon reinvestment period of early June.
1-week U.S. Treasury repo vs. 7-day SIFMA
Yield (%)
Source: Bloomberg, L.P.
Past performance is no guarantee of future results.
Beyond the weekly space, yields remained relatively stable as the longer end of the curve was mostly exempt from seasonal cash-flow changes, while interest-rate expectations continue to be defined by Fed policy. Rates on high-grade tax-exempt commercial paper and notes in the 30- to 90-day range edged tighter by roughly a basis point or two throughout the month, while yields on paper maturing in the six-month to one-year range also barely budged. Top-rated one-year paper continued to yield roughly 0.20% heading into the beginning of note season, when we see an annual surge in the issuance of municipal cash-flow notes.
We continued to favor daily and weekly VRDNs and TOBs in our portfolios due to their favorable liquidity characteristics and their relative value on both a taxable and tax-exempt basis. We have also modestly increased our fixed-rate exposure by adding high-grade commercial paper and cash-flow notes in the 30- to 90-day range, locking in attractive rates heading into the heavy June reinvestment period. Still, in the face of persistently low absolute yield levels and a generally flat yield curve in the municipal money market space, we maintained a relatively short weighted average maturity in our funds.
On the horizon
The Securities and Exchange Commission (SEC) will hold (or have held, depending on when you are reading this) an open meeting on June 5 to consider a recommendation to propose additional money market fund regulation. If the SEC approves the recommendation, it will mark the beginning of what is typically a lengthy process that includes public comment and review. At this point, there is nothing to indicate that our money market funds should deviate from our current portfolio strategies and our emphasis on safety and liquidity.
View current money market fund performance.
View a list of complete holdings for the money market funds.
1. The SIFMA Municipal SWAP Index, produced by Municipal Market Data (MMD), is a seven-day high-grade market index composed of tax-exempt variable-rate demand obligations from MMD's extensive database. You cannot invest directly in an index.
A portion of the Municipal Money Market Fund's income may be subject to federal, state, and/or local income taxes or the alternative minimum tax (AMT). Any capital gains distributions may be taxable. For the government money market funds, the U.S. government guarantee applies to certain underlying securities and not to shares of the fund.
The views expressed and any forward-looking statements are as of 5-31-13 and are those of the fund managers and the money market team at Wells Capital Management, subadvisor to the Wells Fargo Advantage Money Market Funds, and Wells Fargo Funds Management, LLC. Discussions of individual securities, or the markets generally, or any Wells Fargo Advantage Fund are not intended as individual recommendations. Future events or results may vary significantly from those expressed in any forward-looking statements; the views expressed are subject to change at any time in response to changing circumstances in the market. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.
