* Money market funds may have to sell debt if US defaults
* Some funds choosing cash over US government securities
* Money market pressures ease ahead of European summit
By Chris Reese and Emelia Sithole-Matarise
NEW YORK/LONDON, July 20 (Reuters) - While money market funds may not take a direct hit to their U.S. government securities holdings if the U.S. credit rating is downgraded, they might suffer in the event of a credit default, a strategist said on Wednesday.
Ratings agencies have said the United States is at risk of having its top-notch credit rating downgraded if it does not soon raise the debt ceiling and deal with a growing budget deficit. Washington also risks defaulting on its debt obligations if the debt ceiling is not raised by an Aug. 2 deadline.
“In the event of a downgrade, money funds and other rated short-term funds wouldn’t be forced sellers of Treasuries or agencies just because of the downgrade,” said Alex Roever, head of short-term rates strategy at J.P.Morgan in New York.
However, “in the event of default, some investors might be required to sell defaulted Treasuries,” Roever said, which could undermine the value of those securities.
A downgrade alone likely would not force money market funds to sell U.S. Treasuries to meet their liquidity requirements, Roever said.
“From a credit perspective, the good news is that the implications of a U.S. credit downgrade on money funds should be fairly minimal,” he said. “A one or two-notch downgrade of the U.S. government would not precipitate the need for money funds to dispose of their government holdings — they may continue to use those securities to comply with their liquidity requirements.”
Money market funds are already girding themselves against a potential U.S. credit downgrade or debt default by leaving investments in cash rather than buying Treasuries, Roever said.
“If you are looking for a sign that the debt ceiling crisis is impacting the Treasury market, here is one: rather than buying short-term government debt at current yield levels and run the risk of yields rising upon a rating downgrade or default, at least some fund managers are choosing to leave their cash in the bank instead.”
Outside of the U.S. downgrade worries, money market pressures cooled on Wednesday on optimism that European policymakers may reach a deal to help debt-ridden Greece, though doubts they will deliver a permanent solution for bigger economies kept improvements in check.
Lower-rated euro zone government bonds won some respite from the recent sell-off after French ministers said EU policymakers were likely to reach an accord at a summit on Thursday to ease Greece’s debt crisis and avert a default.
The ructions in debt markets had led to a rise in premiums in the rates banks charge to lend to each other as the crisis threatened to send Italian and Spanish borrowing costs to unsustainable levels.
London interbank offered rates for three-month euros EUR3MFSR= fell to 1.54813 percent on Wednesday from 1.55375 percent on Tuesday, according to the latest fixings by the British Bankers’ Association.
The gap between three-month Libor and expectations of central bank rates — a measure of counterparty risk — eased slightly to 25 basis points from 26 bps, though this was still near the upper end of its recent range.
“By and large the panic has subsided ... we saw Libor creep up last week but it has eased,” said Chris Huddleston, head of money markets at Investec in London.
“I don’t think there’s any danger of a surprise tomorrow. However, I do think the Greek issue has all the potential to blow into something much more serious with fallout in Italy leading to increased volatility in money markets.” (Editing by Dan Grebler)