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A $300 Billion Exodus

Recently, regulators within the US have taken a closer look at the money-market industry and its $2.6 trillion worth, and a large part of those investments may end up fleeing the country, and the market. As much as $300 billion could simply evaporate from their sight, leaving money managers in a state of panic and disbelief, sending ripples throughout financial markets, and providing binary options traders with some possible investment opportunities. For more on binary options trading, visit here.

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A Prime Problem

The bulk of the problem is in the so-called prime funds, which specialize in buying securities such as commercial paper and whose assets have already dropped by almost $90 billion over the course of last year, according to Investment Company Institute. This in turn has decreased the demand for short-term debt that belongs to banks and companies alike, which means funding is a lot more difficult to obtain as a result.

For most investors, the money-fund industry has served as a parking lot for their cash, keeping the value of their assets and possibly away from prying eyes of regulators and taxmen alike. However, after the most recent crisis, there have been some major changes aimed at making the financial system more resilient to another credit crisis that could pop up at any time.

So, starting on Oct. 14, tax-exempt funds as well as their prime counterparts will no longer be allowed to fix their shares at $1 value, effectively disabling them from acting as a backup currency. For the past 30 years, investors could convert their money into these shares on a 1-1 ratio and simply sell them after a while. From now on, only funds with government debt will be allowed to continue with this practice, which will eliminate most of the financial incentive of investing into prime funds. This does not bode well for companies which specialize in this type of funds, so many of them have already done what they can to reduce these offers and introduce viable substitutes.

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Time of insecurity

While some managers view this as a simple repositioning of funds, even they agree that the outflow of funds will be measured in hundreds of billions of dollars. Sources range from $200 billion (Northern Trust Corp., Chicago) to $300 billion (TD Securities). Any short-term debt that matures after September is considered toxic and some have gone so far as to suggest that prime funds may institute redemption fees in order to keep some of the money in play.

On the other hand, at least some of this money is bound to end up in Treasuries, used to buy some of that lucrative government debt. With this in mind, agency securities and repurchase agreements may find little trouble in reaching new owners, especially since they are the loophole that is left by the rules, whether deliberately or not.

Copyright: mattz90 / 123RF Stock Photo
Copyright: mattz90 / 123RF Stock Photo

Soaring Libor

Possibly the biggest effect that this movement will have will be felt on forex markets as well as any derivatives based on currency pairs. Since the majority of banks have been relying on prime funds to ensure a steady supply of funds, usually via commercial paper and similar instruments, which made certain lending rates skyrocket. The Libor in the last three months has not been this high since 2009, which should give us an estimate. Whether a similar crisis will pay and now as a result, it remains to be seen.

In any case, Libor is expected to stabilize by the end of October, but probably will not fall that much, as the Federal Reserve interest rate may rise relatively soon. The end of the month should see it at 0.95% but that should be about it. Besides, prime funds will be down but not out – the lack of funding is temporary, which is exactly what makes it perfect for binary options traders to exploit the volatility that will result from it.

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Conclusion

Even though costs of funding banks are rising, which will affect the US dollar and in turn any other currency paired up with it to an extent, this is not a crisis that is permanent in nature; this money is simply changing location, leading to some turbulence but things are far from catastrophic. A huge chunk of commercial paper and other certificates of prime funds are expected to mature by the time the law comes into effect, and the way things play out will largely depend on Fed’s rate.

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