CICC: Challenges and Responses of Money Market Funds in the Era of Low Interest Rates

According to the Zhitong Finance APP, CICC has released a research report stating that the recent four major banks have lowered deposit rates, with the one-year fixed deposit rate dropping below 1%. Additionally, with the reduction of the 7-day repurchase rate, the annualized yield of money market funds is also approaching 1%. In the future, before the monetary market rates complete their adjustments, inflation may continue to decline, thereby raising real interest rates, which remains beneficial for the overall scale of low-risk assets such as money market funds. Next, after a significant adjustment in monetary market rates, there may be a marginal push for funds to flow out of money market funds.

CICC's main viewpoints are as follows:

From the perspective of the United States, the yield of U.S. money market funds entering the "1%" era has occurred in three periods: 2003-2004, 2009-2017, and 2020-2021. Analyzing these three historical periods reveals that during the interest rate cut cycles, the scale of U.S. MMFs slowed down or showed a significant decline.

From the Eurozone perspective, the yield of Eurozone money market funds entering the "1%" era occurred between the third quarter of 2009 and the fourth quarter of 2022, which can be further divided into two periods of positive and negative interest rates around mid-2014. During the positive interest rate period, the decline in rates entering the 1% stage led to a significant drop in the scale of money market funds; whereas during the negative interest rate phase, the scale of money market funds did not further shrink but rather tended to recover, which is related to the demand for institutional investors' subscriptions due to bank deposit rates being lower than money market fund yields.

In Japan, negative interest rates have led to the demise of MMFs, while the MRF linked to securities accounts has thrived due to policy protection from bearing negative interest rate costs.

From the analysis of historical scale changes of money market funds in major overseas markets, some common patterns can be summarized regarding the driving forces behind the changes in money market fund scales. CICC identifies three main reasons: (1) the different elasticities of nominal interest rates to changes in policy rates leading to different betas; (2) the different interest rate systems in different regions, with the European Central Bank and the Bank of Japan implementing negative interest rate operations differently, resulting in different circumstances for MMFs; (3) the impact of inflation on real interest rates leading to varying market demands for overall low-risk assets.

From overseas experience, the central bank's interest rate cut cycle often poses challenges for money market fund managers. Due to the high beta value of money market fund yields, the decline in money market fund yields during a rate down cycle is often faster than that of deposits, putting pressure on fund managers from outflows. To address this challenge, overseas money market fund managers have adopted several strategies, including fee reductions, exploring credit on the asset side, liquidity or ESG premiums, building product ecosystems, and increasing overseas investments. For regulatory authorities, one response to mitigate the impact of low interest rates on the money market fund industry is to promote the valuation transformation of money market funds from amortized cost method to market value method.

For China, the interest rate transmission system is dual-track, meaning both deposit and loan rates and money market rates operate on separate tracks. Therefore, the beta values of money market rates and deposit rates are influenced not only by the market but also by policy rates. Before 2023, the elasticity of money market rates compared to the 7-day repurchase policy rate was much higher than that of deposit rates. However, since 2023, due to frequent adjustments in the self-discipline mechanism for deposit rates, Therefore, the beta value of deposit interest rates is actually higher than that of money market interest rates. Thus, it can be seen that in the years when the beta value of money market interest rates was higher (i.e., before 2023), similar to the experiences in the United States and Europe, the central bank's monetary policy cycle has a crucial impact on the industry scale of money market funds.

After 2023, deposit interest rates have been lowered more rapidly, while the scale of money market funds continues to maintain high growth. It is precisely because of the dual-track system that our central bank can achieve precise control over various interest rates. Therefore, whether China's MMF will continue to exist in the future, as interest rates continue to decline, depends on whether the central level of money market interest rates will drop significantly below the level of deposit interest rates. It is expected that in the future, money market interest rates will experience a significant correction, and marginally, this correction will be unfavorable for money market funds, causing the growth of money market fund scales to slow down or even potentially decrease. However, the likelihood of money market interest rates dropping into negative territory is very low, and even if interest rates are corrected, it is difficult for them to fall far below the interest rates of major banks' demand deposits. Therefore, it is expected that China's money market funds will likely continue to exist.

In the future, before the money market interest rates complete their correction, inflation may still maintain a downward trend, thereby raising real interest rates, which remains favorable for the overall scale of low-risk assets such as money market funds. Next, after a significant correction in money market interest rates, this may marginally drive funds out of money market funds. Therefore, for money market fund managers, preparing in advance for this challenge is a wise strategy, such as promptly building a customer ecosystem system, increasing customer stickiness; preparing for fee reductions and benefits; and enhancing the company's investment research capabilities.

Risks

Overseas experiences are not applicable to our country