Nearly $90 billion pours into US money market funds ahead of expected rate cuts

Nearly $90 billion poured into U.S. money market funds in the first half of August as investors sought attractive yields that could survive an expected interest rate cut by the Federal Reserve next month.

Money market funds, which hold cash and short-term assets including government debt, posted net inflows of $88.2 billion between Aug. 1 and Aug. 15, according to EPFR, the biggest figures in the first half of the month November last year. .

Most of the flows came from institutional investors — large entities that invest on behalf of others — rather than retail investors, the data showed.

Industry participants said the influx of money reflected institutional investors’ positioning for a cut in interest rates from the current 5.25-5.5% starting next month.

Treasury bond yields typically fall before an expected interest rate cut and fall even more immediately after rates fall, they added, but money market funds can offer higher rates for longer because they have larger holdings. diversified.

“The institutional growth we’ve seen has only been in the last two weeks,” said Shelly Antoniewicz, deputy chief economist at the Investment Company Institute. “The reason is that it’s pretty clear now that there’s a much better chance that the Fed will ease in September.”

Inflows into money market funds so far this month highlight how the vehicles continue to compete with short-term stocks and bonds as a haven for investors’ cash.

Money market funds had a boom in 2023 as rates rose to a 23-year high to combat inflation. Net inflows hit a record $1.2 billion last year, according to EPFR data, helped by strong demand from retail investors. Industry participants say institutional investors are following suit.

“This is something that happens quite regularly when interest rates start to come down,” said Deborah Cunningham, investment director of global liquidity markets at Federated Hermes. “As yields on these straight securities have fallen with expectations of further Fed rate cuts, (investors) would prefer to hold the yield of a money market fund for a longer period of time.”

US money market funds are allowed a so-called weighted average maturity of up to 60 days, meaning they can hold a diverse range of securities – from debt maturing in three or six months to assets with a much shorter period.

The average US money market fund currently yields 5.1%, according to Crane Data. By comparison, a one-month Treasury bill yields a slightly higher 5.3 percent, and a three-month note 5.2 percent. Sofr, the overnight credit rate, is 5.32%.

However, “it is direct securities such as overnight commercial paper, overnight depository receipts . . . (they) will change instantly if or when the Fed starts to ease,” Antoniewicz said, referring to an anticipated drop in yields on short-term assets traded directly in the market.

Although inflows have continued this year, they have slowed as interest rates have stabilized. Money fund managers and strategists say there are already signs that retail investors are branching out into riskier asset classes such as stocks.

However, they noted that August’s inflows were an early sign of more institutional money flowing into the asset as large companies that need easy access to capital for operations also seek a return on cash.

“If you’re a cash manager for a large institutional corporation that has a substantial amount of cash in the market, 10 basis points, 20 basis points can make a huge difference, even if it’s just for a month,” Cunningham said.

Market participants also said they expected the Fed’s interest rate cuts to be gradual rather than quick and deep, which would mean that money fund yields would fall over a long period of time.

Weak US jobs data at the start of the month fueled fears of an impending recession. Stronger economic data calmed those concerns, but markets are still pricing in just under a full percentage point of cuts through the end of the year.

However, John Tobin, chief investment officer at Dreyfus, noted that “every rate cut in recent history has been a function of cutting rates to zero because there was a financial crisis.” Instead, he said, “here, assuming that’s not the case, we’re now talking about terminal rates with at least 3 (percent) leeway.”

This implied that money market funds could continue to attract assets long after the Fed cut rates. This time, “funds are better positioned,” he said.

Still, industry participants accept that the ability of money market funds to attract persistent inflows rests on the durability of the U.S. economy, allowing the Fed to slightly reduce the cost of borrowing.

Cunningham described rates above 3% as the “magic hurdle”. “If you start to get below 3 percent, then people start to get a little bit of an itch for that and go into other products.”