Money market is the term for the various markets where short term debt instruments are traded. Money market instruments have maturity dates ranging from overnight to just under 1 year.
Shape of the Money Market
The money market is intended for institutional investors that need to make wholesale trades to cover inflows and outflows of cash, meet debt obligations and satisfy capital requirements, though there are a variety of ‘money market funds’ that operate in the money market on a purely speculative basis.
The base trading unit in the money market is $5 million, but it is not uncommon for trades of $1 billion or more to take place.
Many of the transactions that take place in the money market are the product of overnight clearance dominated by large banks and other major financial institutions.
As these entities are constantly shifting a huge number of transactions between various market entities, they are often in need of a large range of different debt instruments to ensure that they can balance their books at the end of each business day.
The overnight money market is also where much of central bank policy action is undertaken, as the central banks can influence the overnight rate that banks and other major financial institutions are forced to pay by adding and withdrawing liquidity in the overnight money market.
The higher the rate that banks and other major financial institutions need to pay to balance their books in the overnight money market, the less liquidity they will tend to provide to the economy as a whole, and vice versa for lower overnight rates.
The other major source of activity in the money market is from corporate notes, which are essentially a tradable IOU with extremely variable and flexible terms issued by corporations in need of quick cash injections.
Unlike traditional bonds, corporate notes are not intended to fund overall long term operations, but rather to simply ensure adequate cashflow for the day to day operations of the company. Corporations may issues a corporate note to pay for inventory, to cover for accounts receivable in arrears and so on.
Trading and the Money Market
Individual day traders will not have access to trading in the money market, but they can track money market activity to get a sense of overall economic activity, interest rate changes and central bank activity.
While the money market may feel divorced from the every day experience of most day traders, what transpires there, particularity in the overnight market, often provides very clear signals for upcoming changes in other asset classes.
Many day traders overlook the importance of the money market in terms of its impact on business activity and other asset classes. A comfortable understanding of the basics of the money market is a valuable addition to every day trader’s ability to forecast overall market trends.