Did Powell just trigger a cash drain?

Unlock Editor’s Digest for free

FT editor Roula Khalaf selects her favorite stories in this weekly newsletter.

Jay Powell, the chairman of the Federal Reserve, scored a big win this week as the US central bank kicked off its rate-cutting cycle with a bang, cutting half a percentage point from its benchmark.

Typically, this is a red flag for markets — a signal that the economy is in bad shape or that the central bank knows it’s tapering too late. However, Powell convinced investors that this was a luxury decision. He cut rates hard because he can. This clever play by the central banker managed not to spook the horses; stocks and bonds have largely held their composure.

Now, the common assumption is that the rate cut — the start of a long streak, judging by the Fed’s messages — will cause a huge wave of investor-held cash to spill onto the shores of risk markets. Any day now, it will start landing. Just wait. It sounds too good to be true, and it probably is.

By “cash”, we’re not talking so much about polymer bills and metal coins, nor even so much these days about bank deposits, which pay vanishingly low rates in the US. Instead, investors focus on short-term deposits — money market funds and the like — that have interest rates that closely mirror central bank benchmark rates.

Asset managers have said for months that the play is available for money, which had its most recent moment of glory in the inflationary burst of 2022, providing a safe haven as stocks and bonds tanked. This year and last year, sensible people have repeatedly told me that it doesn’t make sense to hold out in the run-up to the rate cut cycle. When the piles of cash continued to accumulate anyway, they said the outflows would begin when rates began to fall. All the money sitting on the sidelines is about to be unleashed. Again, any day. Well, now the day has come, so we’ll see if they’re right.

It’s hard to ignore the size of this asset class. Taken together, money market funds are easily north of $6 billion in the US, up 15% from the start of last year and up sharply even before this week’s rate cut.

Gene Tannuzzo, global head of fixed income at Columbia Threadneedle, called this affection for cash “T-bilt and chill.” (Treasury bills are Treasury securities or US government debt instruments with a maturity of less than a year, and financial jokes are generally bad, what can I say?) Now, he says, “cash is cool, but bonds they are better”.

The problem, for fund managers in riskier or longer-dated asset classes salivating at the idea of ​​capturing some of that cash on the way out, is that a “T-bill and chill” strategy still yields around 4.5% in the USA. . Investors say this poses a high hurdle when trying to lure customers. Ten-year US government bonds are still yielding well below 4%. And if we have a nasty global recession, even with falling interest rates, investors tend to flock to the safety of cash. For many, it still feels like a cozy, warm blanket that’s easy to access.

Deborah Cunningham, chief investment officer for global liquidity markets at Federated Hermes, said in a presentation this week that she still expects cash to come in, in part because the impact of the rate cuts is taking a while to trickle down. She still expects assets in this area to reach $7 billion. Investors don’t tend to hang on to the cash rate until it falls to 1% or below — an unlikely scenario in this more inflationary post-pandemic world, or at least one they hope never to see again in her lifetime , she said.

“Contrary to what many others are currently saying, which suggests a mass exodus of cash from money market funds during falling rates, the historical data tells us otherwise,” she said. Unlike US bank deposit rates, which can often be below 1%, “rates can be 3% and money market funds still look attractive,” she added.

It still seems reasonable to assume that money will flow out of cash and into higher-yielding assets as benchmark rates fall, at least eventually. But where will it go? Equity fund managers say they’re heading to equities, government bond fund managers say government bonds, and credit fund managers, surprisingly, say credit. The latter group there may have the strongest case – their asset class offers only a slightly higher return than government bonds, less dramatic than stocks and, at least for the safest companies, very low risk of default .

Meanwhile, the stickiness of cash is a source of irritation. “There was such strong demand for cash products,” said Joop Kohler, head of credit at Dutch asset manager Robeco. “I totally understand, but it’s also frustrating that we don’t see $800 billion coming back into the credit market. The timing is changing, but we’d like to see it sooner.”

Professional investors looking longingly at the huge accumulation of boring old cash funds should remember that $6 billion sounds like a lot of money. That’s a lot of money. But it’s still less than the market capitalization of two apples. Perhaps the most likely outcome is that the much-vaunted wave of cash will prove to be a slow trickle that spreads widely across riskier asset classes without making much noise.

[email protected]