BIS: money market funds and pricing of near-money assets

US Treasury bills (T-bills) and repurchase agreements (repos) are among the most important financial instruments in global finance, and US money market funds (MMFs) are key components of both the T-bill and repo market. It remains an open question as to what extent the portfolio allocation of MMFs affects the pricing of these short-term assets, and whether MMFs create interdependencies between the repo and T-bill markets.

Researchers from the Bank for International Settlements (BIS) develop a theoretical framework to clarify how money market funds affect the pricing of short-term assets through their strategic interactions with each other and with banks. They provide empirical evidence in support of the theoretical channels. The results contribute to the literature on the pricing of near-money assets, with implications for the transmission of monetary policy and the role of central bank balance sheets, government debt issuance and repo-based benchmark rates.

Findings show that when MMFs allocate more of their assets under management to the T-bill market, T-bill rates fall and the liquidity premium on T-bills rises. Guided by the researchers’ theory, they develop an instrumental variable to show that this finding is causal. Using a granular holding-level data set to examine the channels, they show that MMFs internalize their price impact in the T-bill market when they set repo rates and tilt their portfolios towards repos with the Federal Reserve when Treasury market liquidity is low.

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