Portfolio Manager Commentary

Overview, strategy, and outlook: As of April 30, 2018

Money market overview

The end of April seems to serve as an inflexion point of sorts for the money markets. Experience has shown that it represents a turning point at which seasonal outflows from money market funds stop, or at least stabilize, followed by a gradual buildup in assets in the second half of the year, accelerating into year-end. The first four months of 2018 seemed to be holding to this pattern; total money market fund assets fell from $2,935 billion to $2,877 billion, a decrease of 1.97%. This number seems to be quite smaller than previous years.

A closer examination reveals that the size of the decline is being partially masked by an inflow to prime money market funds. Those funds declined by 2% through the end of March, falling $18 billion, before gaining $19 billion in assets during April. Following implementation of money market reform in October 2016, most transactional deposits shifted to government money market funds. This would suggest that outflows in government funds should exceed those of prime funds, and they do. Government funds fell from $1,558 billion at the end of 2017 to $1,486 billion at the end of April, a decline of 4.62%. This number also seems to be a little low in contrast to previous years. Between January 31 and March 7, institutional government funds experienced inflows of $47 billion, and it would appear that some of that money has stuck around. The origin of the funds is a mystery, though two sources are distinct possibilities. Some of it could be from the equity markets, which sold off over 10% in the two weeks that ended February 8 and then continued to trade in volatile ranges for the rest of the quarter. During February and the first week of March, nearly $24 billion flowed out of domestic equities. Some of it could also be deposits that are related to repatriation—whether being held in cash for anticipated tax payments or for capital expenditures anticipated over the near term, such as dividend payments and share repurchases. If these deposits are temporary, it’s likely that their outflows later this year will have an offsetting effect on any seasonal inflows, smoothing out asset spikes in the short end.

Sector views

U.S. government sector

After a momentous March, the front end took a break in April to consolidate all of the recent activity. Following the debt ceiling resolution in early February, the balance of the first quarter saw the U.S. Treasury issuing Treasury bills (T-bills) as if its printing presses were going out of style, issuing $332 billion in net new additional T-bills. The supply surge, meant to fund tax refund outflows and rebuild the Treasury’s cash balance, pushed rates higher across all of the instruments in the government money market sector: repos, Treasuries, and agency securities. It also soaked up the biggest pool of underinvested assets, as the money that was invested daily in the Federal Reserve’s (Fed’s) reverse repo program (RRP) fell from an average of $42 billion in January and February to an average of $11 billion in March. For comparison, the daily average for all of 2017 was $144 billion.

As March turned to April, we knew the Treasury would turn from a tax refund payer to a tax payment recipient and that about one-third of the preceding supply surge would reverse as a result. What we didn’t know was the effect the supply change would have on the markets or that we would see 26 inches of snow in April instead of tulips. April did see $120 billion of T-bill paydowns, and the market was surprisingly resilient. The yield on Treasury repos, which had over the course of 2016 and 2017 traded an average of 3 basis points (bps; 100 bps equal 1.00%) over the Fed’s RRP rate, surged with supply, averaging 22 bps over the RRP from mid-March until the supply cuts began in mid-April and peaking at a 31-bp spread on April 3. Over the balance of April, repo rates pulled back only modestly, averaging 18 bps over RRP, as shown in the chart below. A few weeks of trading is not enough to reach even a modest conclusion for any market, let alone one as opaque and mysterious as the repo market, but at a minimum we can say the supply contraction did not initially put much of a dent in repo rates.


Excess of tri-party repo over RRP

Chart 1: Excess of tri-party repo over RRP

Sources: Federal Reserve Bank, Bloomberg L.P., and the Bank of New York


Likewise, the yield on 1-month T-bills, as shown in the chart below, had historically traded in about a 10-bp range approximately capped by the RRP rate, unless a Fed rate hike was imminent, at which point the yield would temporarily move 10 bps to 20 bps above the RRP to price in the next hike before settling back below the RRP. As with repo rates, T-bill yields have at least initially settled into a post-hike, post-supply contraction range that is 15 bps to 20 bps higher than its recent ranges.


1-month T-bill yield and RRP spread

Chart 2: 1-month T-bill yield and RRP spread

Sources: Bloomberg L.P. and Wells Capital Management Inc.


We’ve mentioned this in the past, but the folks at the Treasury typically have had a nice read on their cash flows, with expectations finely honed by experience. Unfortunately, no one has experience with the new tax law, with individuals, companies, and the Treasury all learning on the fly. Eventually, the combination of lower tax collections stemming from the new tax and higher outflows due to the generous budget will mean a further increase in T-bill supply, but the net effect of the recent supply roller-coaster has left the Treasury with a cash balance near its recent peak at around $400 billion, as shown in the chart below. With the Treasury aiming for an end-of-June cash balance of $360 billion, the near-term outlook for T-bill supply is unclear—unlike the recent period, when the first quarter’s net addition and April’s net reduction were generally well expected. This will give the market some time in a relatively static supply environment and give investors time to identify the new trading ranges.


U.S. Treasury cash balance

Chart 3: U.S. Treasury cash balance

Source: Bloomberg L.P.


Prime sector

Last month we called attention to the dramatic widening of the London Interbank Offered Rate and Overnight Index Swap (LIBOR-OIS) rate spread. It represents the difference between an interest rate with some credit risk built in (LIBOR) and one that is relatively risk free (OIS). The spread stayed elevated (setting at more than 59 bps) through the first week of April and then began to retrace off the highs, especially after tax time. While we contend that the current spread widening was due to supply and demand imbalances and not credit stress, several of the imbalances started to work out in April. One large factor had been the increase in T-bill and repo supply (see the government section) that was naturally paid down with tax receipts. Another imbalance was the decline in prime assets in the first quarter that also turned around this month. So while the LIBOR-OIS spread is still at higher-than-average levels, it seems that the peak is behind us for this episode.


LIBOR-OIS spread

Chart 4: LIBOR-OIS spread

Sources: Bloomberg L.P. and Wells Capital Management Inc.


As measured by Crane Data, prime institutional assets were up $14 billion in the month of April. Commercial paper outstandings were also up but just back to the amount outstanding at the end of February. Contributing to the light issuance was quarter-end for Canadian banks and fiscal year-end for Australian banks this month. With an increase in demand not matched by an increase in supply, the money market sector experienced a contraction in yields even as LIBOR itself continued to climb, albeit at a slower pace. Three-month LIBOR ended the month at 2.36%, up 5 bps over March, after increasing 62 bps in the first quarter of 2018 (along with one 25-bp Fed tightening in March). Where yields on high-quality fixed-rate paper were trading at positive spreads to LIBOR most of the first quarter, the demand/supply imbalance took those spreads to even with, or in many cases below, the index.


LIBOR yield curves

Chart 5: LIBOR yield curves

Sources: Bloomberg L.P. and Wells Capital Management Inc.


Money market yield curves

Chart 6: Money market yield curves

Sources: Bloomberg L.P. and Wells Capital Management Inc.


New this month, the Fed began publishing the Secured Overnight Financing Rate (SOFR). This was launched to be the eventual replacement of LIBOR. The rate itself is volume-weighted, based off collateralized overnight investments, including tri-party repo, general collateral financing, and Fixed Income Clearing Corporation trades. The purpose of replacing LIBOR, an index of voluntary quotes by banks, with one based on actual transactions is to eliminate the chance of participant manipulation. Because the SOFR is a pure overnight rate, CME Group is to launch a futures market tied to SOFR to flesh out the rates in term structure. The current intention is to phase out LIBOR by year-end 2021.

Economic data published this month continued to be supportive of the Federal Open Market Committee (FOMC) assessment that it could continue to remove accommodation at a gradual pace. The market currently interprets gradual pace as 25 bps each quarter. The economy is operating in above-trend growth in terms of 2.3% gross domestic product, improving inflation situation (CPI 2.1%; PCE 1.9%), and a still historically low unemployment rate (4.1%), so a gradual pace does not seem unreasonable. The FOMC Summary of Economic Projections at its March meeting suggested that it was a close call if its target rate would be raised three or four times this year, and current data set shouldn’t change that projection.

Given the backdrop of favorable economic conditions and an FOMC that is anticipating removing accommodation for the foreseeable future, we continue to favor maintaining our funds’ weighted average maturities shorter than the industry average while still offering a favorable risk-adjusted yield. These shorter profiles afford us the flexibility to add longer-dated product as opportunities arise. While rates in general continue to drift higher, we believe our investment strategy of emphasizing highly liquid portfolios, relatively short weighted average maturities, and a position in securities that reset frequently should allow us to capture future FOMC rate moves with minimal NAV pricing pressures.


Wells Fargo FNAV money market fund NAVs

Chart 7: Wells Fargo FNAV money market fund NAVs

Source: Wells Fargo Funds


Wells Fargo FNAV money market fund weekly liquid assets

Chart 8: Wells Fargo FNAV money market fund weekly liquid assets

Source: Wells Fargo Funds


Municipal sector

Tax-season volatility was in full effect during the month of April in the municipal money market space. Yields rose across the curve as persistent fund outflows continued to exert downward pressure on demand throughout the month. After losing roughly $3 billion in assets during the month of March, municipal money market funds experienced outflows just north of $1 billion during April. The reversal in asset flows over the past two months has resulted in dramatically higher rates compared with earlier this year on short-term variable-rate demand notes (VRDNs), tender option bonds (TOBs), and other short-term municipal securities. The Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Index1 spiked to 1.81% on April 18, up from 1.58% at the end of March.

As a result, the SIFMA to 1-week LIBOR ratio reached 104%, prompting opportunistic crossover buyers to quickly swoop in to the tax-exempt space and providing an element of support amid dwindling demand from traditional buyers. The SIFMA Municipal Swap Index finished out the month at 1.75% as selling pressure faded. Further out on the curve, yields on tax-exempt high-grade paper rose by roughly 25 bps in the one-month to six-month space. Meanwhile, yields on top-notch one-year paper inched up roughly 15 bps, closing out the month at roughly 1.78%.

During the month, we continued to concentrate our purchases in VRDNs and TOBs with daily and weekly put options in order to maximize portfolio liquidity and capitalize on rapidly rising rates in the short end of the curve. This strategy has allowed us to quickly capture higher market-level yields on floating-rate securities while maintaining an emphasis on liquidity and principal preservation. In our opinion, the relative flatness of the municipal money market yield curve in the face of expected rate hikes by the FOMC in the coming months continues to warrant lower weighted average maturities. While we do expect rates in the short end to normalize over the next few weeks, we continue to feel confident that tax-exempt money market yields should remain compelling on both a nominal and taxable-equivalent basis.


On the horizon

May is setting up to be a pretty quiet month in the markets, with tax receipts in the bank, so to speak; bill issuance muted; prime fund assets flat; and a Fed expected to be on hold until its June meeting. While the Fed will have met on May 2, virtually no one expects the Fed to hike rates. The market assigned a near-zero probability to the event as the meeting approached, so the potential for related volatility arises if the Fed departs from the data-dependent, slightly hawkish path it charted at the last meeting. Based on the Fed’s measured approach to normalization and its deliberate pacing, we are anticipating at least two more tightenings this year, with a third becoming more possible as the year advances and incoming data continue to suggest an economy perking along at near-full employment.


Rates for sample investment instrumentsCurrent month-end % (April 2018)

Sector 1 day 1 week 1 month 2 month 3 month 6 month 12 month Wells Fargo Fund 7 day current yield
U.S. Treasury repos 1.72 1.71 Cash Investment MMF*–Select 1.91
Fed reverse repo rate 1.50 Heritage MMF*-Select 1.92
U.S. Treasury bills 1.62 1.69 1.80 1.96 2.17 Municipal Cash Mgmt MMF*–Inst'l 1.61
Agency discount notes 1.53 1.55 1.62 1.70 1.78 1.89 2.19
LIBOR 1.70 1.75 1.91 2.07 2.36 2.51 2.77 Government MMF**-Select 1.59
Asset-backed commercial paper 1.73 1.76 1.91 2.13 2.32 2.53 Treasury Plus MMF**-Inst'l 1.47
Dealer commercial paper 1.65 1.72 1.83 1.97 2.07 2.28 100% Treasury MMF**-Inst'l 1.48
Municipals 1.59 1.75 1.75 1.76 1.75 1.76 1.78

Sources: Bloomberg L.P., Wells Capital Management, Inc., and Wells Fargo Funds


Figures quoted represent past performance, which is no guarantee of future results, and do not reflect taxes that a shareholder may pay on a fund. Yields will fluctuate. Current performance may be lower or higher than the performance data quoted and assumes the reinvestment of dividends and capital gains. Current month-end performance is available at the funds’ website, wellsfargofunds.com.

Money market funds are sold without a front-end sales charge or contingent deferred sales charge. Other fees and expenses apply to an investment in the fund and are described in the fund’s current prospectus.

The manager has contractually committed to certain fee waivers and/or expense reimbursements. Brokerage commissions, stamp duty fees, interest, taxes, acquired fund fees and expenses, and extraordinary expenses are excluded from the cap. Without these reductions, the seven-day current yield for the Institutional Class of the Cash Investment Money Market Fund, Heritage Money Market Fund, Municipal Cash Management Money Market Fund, Government Money Market Fund, Treasury Plus Money Market Fund, and 100% Treasury Money Market Fund would have been 1.77%, 1.78%, 1.51%, 1.51%, 1.44%, and 1.28%, respectively, and the total returns would have been lower. The cap may be increased or the commitment to maintain the cap may be terminated only with the approval of the Board of Trustees. The expense ratio paid by an investor is the net expense ratio (the total annual fund operating expenses after fee waivers) as stated in the prospectus.


1. The SIFMA Municipal Swap Index is a seven-day high-grade market index composed of tax-exempt variable-rate demand obligations with certain characteristics. The index is calculated and published by Bloomberg. The index is overseen by SIFMA’s Municipal Swap Index Committee. You cannot invest directly in an index.

*For floating NAV money market funds: You could lose money by investing in the fund. Because the share price of the fund will fluctuate, when you sell your shares they may be worth more or less than what you originally paid for them. The fund may impose a fee upon sale of your shares or may temporarily suspend your ability to sell shares if the fund’s liquidity falls below required minimums because of market conditions or other factors. An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The fund’s sponsor has no legal obligation to provide financial support to the fund, and you should not expect that the sponsor will provide financial support to the fund at any time.

For retail money market funds: You could lose money by investing in the fund. Although the fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. The fund may impose a fee upon sale of your shares or may temporarily suspend your ability to sell shares if the fund’s liquidity falls below required minimums because of market conditions or other factors. An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The fund’s sponsor has no legal obligation to provide financial support to the fund, and you should not expect that the sponsor will provide financial support to the fund at any time.

**For government money market funds: You could lose money by investing in the fund. Although the fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The fund’s sponsor has no legal obligation to provide financial support to the fund, and you should not expect that the sponsor will provide financial support to the fund at any time.

For the municipal money market funds, a portion of the fund’s income may be subject to federal, state, and/or local income taxes or the alternative minimum tax. Any capital gains distributions may be taxable. For the government money market funds, the U.S. government guarantee applies to certain underlying securities and not to shares of the fund.

The views expressed and any forward-looking statements are as of April 30, 2018, and are those of the fund managers and the Money Market team at Wells Capital Management, subadvisor to the Wells Fargo Money Market Funds, and Wells Fargo Funds Management, LLC. Discussions of individual securities, the markets generally, or any Wells Fargo Fund are not intended as individual recommendations. Future events or results may vary significantly from those expressed in any forward-looking statements; the views expressed are subject to change at any time in response to changing circumstances in the market. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.

Carefully consider a fund’s investment objectives, risks, charges, and expenses before investing. For a current prospectus and, if available, a summary prospectus, containing this and other information, visit wellsfargofunds.com. Read it carefully before investing.

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