Borrowing Costs Sky-Rockets Due to Reforms on Money Market
A jump in their temporary borrowing costs is now being faced by local governments of the United States (US). This is caused by the Wall Street’s money market reorganization amounting to $2.7tn which is now flowing into their financial system.
From zero around March, a key interest rate moved up this week to a basis of 70 points. This rate is used on setting coupon payments for short-term municipal debt.
The Alpine Funds’ portfolio manager, said “This is huge. It has been a double edged strike for the issuers”. The Securities Industry & Financial Markets also known as Sifma has increased rates which shoots it one week above Libor, which is a worldwide benchmark bank borrowing that is unsecured.
Tim Schaefer, a deputy treasurer assigned at one of the states at California, said that it is quite startling since the market was up to a good start for the past 7-8 years. He also added that it is despite the instability, it is absolutely not a reason to give up on it.
This jump in the rates of Sifma will surely hit the market of $175bn for VRDNs, which are variable rate demand notes. Shorter-dated debts which carries a rate with floating interest will reset weekly. According to the data provided by Sifma, Texas, California and New York are the largest state issuers in the country.
The regulators in the US approach of money market fund reform causes the borrowing costs’ upward movement. They invest in temporary debt which is sold by public borrowers, banks and companies. Investors who pull money out of the funds whenever there’s a financial crisis and charge them a certain fee. This reform also may cover stopping an investor from withdrawing money.
However, this reform will only take effect next month. This has already serve as a warning for investors who move their money from prime and tax-exempted funds known to buy debt which is being sold by municipalities in the US.
Assets fell from $266bn to $143bn at the start of 2016, according to the data given by Investment Company Institute. This has been the lowest tax exempted assets the ICI have recorded since 2002.
The drop in investing in funds has led to the increase in the borrowing cost. Karen Mills, a treasurer in Cary, North Carolina, is concerned that about this sudden move. However, 70bp is still a low rate for debt to be issued. She added that they are looking into the situation. There is no longer a need to move the VRDNs’ issuance into money which is fixed-rate if markets will become stable.