In the first half of August, a staggering $90 billion flowed into US money market funds as investors sought to capitalize on attractive yields that could potentially outlast an anticipated interest rate cut by the Federal Reserve next month. This influx of funds marks the highest figures for the first half of a month since November of last year, according to flow tracker EPFR.
The majority of these inflows came from institutional investors rather than retail investors, indicating a strategic move by large entities investing on behalf of others. Industry experts suggest that these investors are positioning themselves for a decrease in interest rates from the current level of 5.25 to 5.5 percent, expected to occur as soon as next month.
Yields on Treasury bills typically decline in anticipation of an interest rate cut and drop even further immediately after rates are lowered. However, money market funds can offer higher rates for a longer period due to their diversified holdings. This has led to a surge in institutional investment in these funds in recent weeks.
Shelly Antoniewicz, deputy chief economist at The Investment Company Institute, noted that the recent increase in institutional investment is a response to the growing likelihood of a Fed rate cut in September. This trend highlights the ongoing competition between money market funds, shares, and short-dated bonds as safe havens for investors‘ cash.
In 2023, money market funds experienced record net inflows of $1.2 trillion as rates rose to combat inflation. This surge in demand was largely driven by retail investors, but industry participants now see institutional investors following suit. Deborah Cunningham, chief investment officer of global liquidity markets at Federated Hermes, explained that as direct securities‘ yields decrease with expectations of further rate cuts, investors prefer the stable yield of money market funds.
US money market funds are permitted a weighted average maturity of up to 60 days, allowing them to hold a diverse range of securities with varying maturity dates. Currently, the average yield of a US money market fund stands at 5.1 percent, slightly lower than the yields on one-month and three-month T-bills. However, the anticipated decline in yields on short-dated assets traded directly in the market could impact the attractiveness of money market funds in the future.
While inflows into money market funds have slowed as interest rates stabilized, August’s surge in institutional investment signals a potential shift in the market. Large corporations seeking yield on their cash reserves are also contributing to this trend, as even small differences in basis points can have a significant impact on their bottom line.
Market participants expect the Fed’s rate cuts to be gradual, leading to a gradual decline in money market fund yields over time. Despite initial fears of a recession sparked by weak US jobs data, more positive economic indicators have eased concerns. However, markets are still pricing in further rate cuts by the end of the year.
John Tobin, chief investment officer at Dreyfus, highlighted that the current rate cuts are not driven by a financial crisis, as seen in previous instances. This suggests that money market funds may continue to attract assets even after the Fed cuts rates. However, the sustainability of these inflows depends on the strength of the US economy and the Fed’s ability to manage the cost of borrowing effectively.
In conclusion, money market funds remain a popular choice for investors seeking stable yields in a changing interest rate environment. As the Fed prepares for potential rate cuts, these funds are well-positioned to continue attracting assets from both retail and institutional investors. The durability of the US economy and the Fed’s approach to monetary policy will ultimately determine the long-term success of money market funds as a preferred investment option.