BIS: US dollar funding markets during the Covid-19 crisis – the money market fund turmoil

Key takeaways

  • Short-term dollar funding markets experienced severe dislocations in mid-March 2020, with funding diverted from unsecured funding markets as investors withdrew and switched to secured funding markets and government MMFs.
  • Outflows from US prime MMFs led to a loss of funding for banks and a significant shortening of funding maturities; this precipitated spikes in indicators of bank funding costs, such as the LIBOR-OIS spread, despite banks not being at the epicentre of the liquidity squeeze.
  • The turmoil highlights broader lessons for MMF regulation, the role of non-banks for monetary policy implementation, and the role of the central bank during stress.

The Covid-19 crisis severely disrupted the functioning of short-term US dollar funding markets, in particular the commercial paper and certificate of deposit segments. Commercial paper (CP) is a form of short-term unsecured debt commonly issued by banks and non-financial corporations and primarily held by prime money market funds (MMFs). Certificates of deposit (CDs) are unsecured debt instruments issued by banks and largely held by non-bank investors, including prime MMFs. Both instruments are important sources of US dollar funding for banks, especially for non-US headquartered banks.

The tensions lingered until end-April and spilled over to other international money market segments. Notably, they were the main factor behind the widening of LIBOR-OIS spreads to levels second only to those last seen during the Great Financial Crisis (GFC), and contributed to wide swings in offshore dollar funding costs. As such, they hampered the transmission of the Federal Reserve’s rate cuts and other facilities aimed at providing stimulus to the economy in the face of the shock.

This Bulletin analyses strains in MMFs exacerbating the stress in US dollar short-term funding during the Covid-19 crisis. Amid escalating market turmoil, market participants wanted to hold cash or something that resembles cash as closely as possible. At the same time, financial intermediaries experienced difficulty accommodating the surge in demand for safe and liquid assets. MMFs, in particular, were strained by this “dash for cash.” Prime MMFs had to liquidate large parts of their portfolios, while government MMFs had to buy more assets to accommodate surging inflows, all in a very short order. Even though, unlike the GFC, banks were not at the epicentre of the crisis, dealers were unable or unwilling to expand their balance sheets sufficiently to intermediate all the rebalancing taking place in money markets. The Federal Reserve’s intervention managed to restore market functioning.

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