Turmoil In the Money Markets

Maybe I should retract some of the sanguine thoughts I offered in my opening comments.I just had a long conversation with a money market trader which gave me a jolt. Overnight Libor was just set at 5.00 percent . One month Libor was set at 3.03 percent which is up about 25 basis points from yesterday.

The proximate cause of the pressure in the money markets is the news late yesterday that the Reserve Fund broke the sacrosanct $1 level and suspended withdrawals from the fund. The fund attributed the situation to its exposure to Lehman Brothers.

This complicates matters in the front end of the market place. The trader with whom I spoke said that “it was as if a veil had been removed” from the market. In his opinion, clients will be examining much more closely the items that individual money funds hold. The base assumption of Mom and Pop that money funds are as safe as bank accounts has been challenged.

The trader said that he expects to see withdrawals and redemptions from funds with the money heading to T bills or the safety of an FDIC bank account. (That is another posting another time.) He noted that there is over $3.5 trillion in money funds and if only a very small percentage of that money is shifted it could cause massive dislocations.

In that event, Money funds would be busy raising cash and not buying CP and other short dated instruments. That would put tremendous pressure on funding levels in the front end.

So just when you thought (or I thought ) that there might be some relief, the saga continues.

Originally published at Across the Curve and reproduced here with the author’s permission.