Safe place: Money market funds were considered a relatively safe way to grow your money until the global financial crash of 2008 (Photograph by Horst Schwalm/Pixabay.com)

The U.S. Federal Reserve raised interest rates again on July 27, in a second sharp escalation a month apart, another 75 basis points, or 0.75 percentage points, added to several earlier actions for a total estimated increase of 2.25 percentage points.

Economic strata and US capital markets reacted positively, viewing this effort by the Fed in monetary policy tightening as another determined strategic move to control US inflation, smooth trade, encourage savings and bring the economy back to a more stable and less “bubbly” state. position.

Likewise, most central banks in other global economies as well as Bermuda – still seeking guidance from the US Federal Reserve – have raised interest rates to varying degrees.

The banking world and the investor world are both negatively and positively affected by central bank interest rate adjustments, both up and down.

Debt, credit and fixed income securities

Mortgages are negatively impacted by rising interest rates, particularly borrowers with adjustable rate mortgages, those whose five-year fixed mortgage rates need to be renegotiated, buyers of new homes, possible rates for credit cards, values ​​and yields of current notes and bonds in principal circulation in the market, commercial or personal lines of credit and related debts. More information on this impact in a future article.

Savings and term accounts

Positively, after years of extremely low interest income payouts (see chart), there are real benefits for savings, term deposits, new savings accounts, old flex accounts, rollovers term deposits and/or inflation-linked deposits, as savers can see. banks raise interest rates.

Savings and time deposits are carried in bank customer accounts as liabilities on a bank’s balance sheet. Another future story will offer a full explanation of this statement.

Bouncing back: the Fed raised interest rates sharply in an attempt to combat the effects of inflation

The interest payment structure is a pure mathematical calculation, X principal amount times a there interest rate, capitalized over a given period. Your term deposit is cash only, liquid with a possible early termination penalty, has no underlying securities and is not traded on an open investment market. It can have a dedicated expiry date or can be compounded indefinitely (also known as a savings account).

Money market UCITS

Money market mutual fund rates are also affected and, reflecting market activity, will react in concert to rising interest rate yields. The interest/dividend payment rate will move up the income scale if central bank inflation control measures continue to push rates higher.

Money market mutual funds can be likened to savings accounts, but they are very different, seen as cash-equivalent securities, used 24/7 by millions of institutional and individual investors in the world.

Understanding the Structure of a Money Market Mutual Fund

The Reserve Fund, the first money market fund in the United States was established in 1971. Imitators soon followed. Currently, the assets of money market funds around the world stand at nearly $5 trillion. Locally, MMMFs first became available and popular at the retail level in Bermuda around the turn of the new millennium (2000). Interest rates were also on the rise at this time.

Some older local investors will remember those euphoric days in the early 2000s when money market mutual funds paid up to 7 or 7.5%, all kinds of tech funds posting gigantic returns and then falling values. collapsing later as the island’s financial institutions opened their doors to new investment centers for their retail clients.

Investing was no longer the preserve of those who had portfolio managers and advisors, it was now open to everyone.

Such an exciting time. Investment had become democratic.

Startup Structure

Money market mutual funds are pools of various types of highly liquid, low-risk, high-quality, very short-term debt securities: commercial paper, bankers’ acceptances, repurchase agreements, as well as treasury bills American and agencies, etc.

They are usually issued for various short-term terms ranging from seven days to less than nine months.

Additionally, the funds have historically maintained a stable net asset value of $1 per share. This is where, because this face value did not fluctuate or show a loss during market volatility, the funds seemed similar in perception to term deposits.

Enthusiastic newbie investors often originally assumed that MMMFS returns were fixed and guaranteed, much like their understanding of term deposits. They have started pouring money from savings/deposit accounts with lower interest rates into these excellent MMMF yields.

Impact of the subprime credit crisis

First, face value could not be maintained as some MMMFs bought CMOs, CDOs and other debt securities, which, although rated low risk and highly creditworthy, were only named. The funds were in a loss position as the subprime market crashed

Two disgruntled investors liquidated accounts uninhibited by the gates, causing many funds to close, including the first – the reserve fund.

Third, the Fed aggressively lowered interest rates.

Investors then saw MMMF rates drop, drop, drop down the interest rate scale in concert with subprime mortgages, the global financial market crash of 2008 as the US Federal Reserve cut interest rates interest to the bone, flooding US markets with “easy” liquidity. to stimulate economic growth.

The result

The market chaos finally receded, stability returned, but the people experienced a long and difficult recession.

And with respect to these money market mutual fund structures, the US SEC has instituted reform regulations to manage and protect investors’ understanding of the products.

Reading all of this, why would anyone want to invest in a money market mutual fund?

There are very compelling reasons.

See you next week for part 2.

References

“How does a monetary fund work”, https://www.investopedia.com/terms/m/money-marketfund.asp/

Bloomberg Inflation Fuels ‘Most Uncertain Period’ in Investors’ Careers by Alex Harris

Martha Harris Myron is a native Bermuda Islander with connections in the United States and author of First Financial Literacy Primer – the Dawn of New Beginnings. The Bermy Island Finance Blog will officially launch on Sunday, August 14, 2022. If interested, you can sign up by emailing [email protected]