While many investors are focused on whether or not the FOMC will raise the Fed Funds rate at its next meeting in September, LIBOR (the London Interbank Offered Rate) has slowly crept up over the past month (nearly 7.5bps in 1-Month Fixings and 17bps in 3-Month Fixings).
Typically, large moves in LIBOR fixings have signaled systemic financial stress. However, the primary driver is more likely attributed to investment flows from institutional prime and municipal money market funds into government funds.
But why the change?
During the financial crisis, the now defunct Reserve Primary Fund (a former large money market mutual fund) lowered its share price below one-dollar per share due to its exposure to debt securities issued by Lehman Brothers. The event resulted in redemptions from institutional money market funds, putting the US financial system under severe stress.
New regulation from the Securities and Exchange Commission will require institutional prime and municipal money market funds to move from a fixed one-dollar share price to a floating mark-to-market Net Asset Value (NAV) whereas US government money market funds will retain the status quo, one-dollar per share NAV. In order to qualify as a government fund, a portfolio is required to invest at least 99.5% of its total assets in cash, government securities, repo agreements or a combination thereof.
The rules will take effect on Friday, October 14, 2016.
While the money market reform rules apply to institutional funds, its impact on increases in LIBOR affect both investors and consumers. A majority of consumer loans which include ARMs, HELOCs, and credit cards are pegged off of LIBOR. Institutional investors who leverage their investments will also borrow money pegged off of LIBOR.
Aside from the Fed’s monetary policies, we expect LIBOR to continue rising as the implementation date nears, increasing interest expense for loans tied to LIBOR.