Market Views: Where will $6.2tn money market assets move as rates fall?
A record $6.2 trillion cash pile in US money market funds is having an outsized impact on global markets. This unprecedented accumulation of funds serves as a 'canary in the coal mine', potentially signalling upcoming market shifts.
In the first half of August, over $80 billion flooded into US money market funds – mostly from institutional investors, as the market braced for the Federal Reserve to start cutting interest rates from September.
According to data from the Investment Company Institute, total money market fund assets reached $6.22 trillion as of 14 August. Institutional investors accounted for 60% of these assets. This represents an increase of almost $1 trillion since early 2023.
A US money market fund invests in liquid, short-term instruments like cash, cash-equivalents, and US Treasuries.
When rate cuts eventually begin, the high yields that investors have enjoyed since 2023 are likely to decrease. This change is expected to prompt investors to redeploy these mega assets into other investment vehicles.
It will also signal investors' increased risk appetite and their willingness to access new opportunities that may arise from the rate-cutting cycle.
This week, we asked fund houses to predict how this substantial 'wall of money' might be reallocated under different economic scenarios.
The following responses have been edited for brevity and clarity.
Craig Bell, head of multi asset portfolio solutions
Eastspring Investments
We believe the Fed will begin the cutting cycle in September and this will begin the process where money sitting in money market funds (MMFs) will start to look for a new home.
Given the first move is likely to be 25 basis points and MMFs will still have a running yield over 5%, we would not expect the rotation to begin until the Fed has done more than one or two cuts. Rather as the Fed moves further and further into the cutting cycle the rotation will gather speed until it becomes a tide.
Ultimately, where the money goes depends on the outlook for the economy and the pace and scale of the cutting cycle that unfolds.
Big picture we see two potential scenarios which will have profound implications; we assume that the majority of assets in US MMFs are held by domestic investors and, given their home bias, we would expect US assets (bonds or equities) to see a disproportionate percentage of the flow.
Were growth to stay positive and the cutting cycle to be gradual as the Fed eases towards neutral (around 2.75%), then the money will go into (US) equities. The pace of rotation will be slow at first but as equities rally alongside increasingly less attractive yields in the MMFs, flows may accelerate into mid-2025. We believe AI stocks may likely benefit disproportionately given the current narratives surrounding these stocks. Ultimately, this scenario could see bubble-like conditions develop in US equities end-2025.
Conversely, should US growth deteriorate rapidly and prompt the Fed to cut rates quickly, the direction of the rotation would likely move to US bond funds. However, investors may prefer the safety of remaining in MMFs despite lower yields.
David Chao, global market strategist for Asia Pacific ex Japan
Invesco
The current high-interest rate environment is only one of the reasons why market participants have parked a record $6.22 trillion into US money market funds and just because the Fed starts to cut rates, doesn’t necessarily portend to a re-deployment of funds elsewhere.
In our base case, which expects a bumpy landing scenario over the next 12 months, it’s likely that the policy rate remains around 3.5%. This would mean that money market yields would likely stabilise around this range, although with a lag. These yields would most likely still be attractive when compared to other cash alternatives.
In the run-up to the rate-cutting cycle next month, I foresee some investors locking in some high yields, which may be more attractive than a short-term certificate of deposits (CDs) or longer-term US Treasuries, whose yields would fluctuate downwards with the rate cuts.
Institutional funds account for around 60% of money market funds while retail is around 40%. When institutional funds exit money market funds, they are apt to allocate to high-quality, shorter-duration assets rather than stocks as institutional investors are motivated more so by safety rather than yields. Retail funds, which make up the minority of money market funds, are more apt to reallocate to stocks.
In conclusion, while money market funds under management have hit an all-time high over the past couple of years, it is likely to stay high even when the Fed starts to cut rates. Allocation to stocks is likely to be lagged and limited.
Ben Bennett, head of investment strategy, Asia
Legal and General Investment Management
Investment flows is not a straightforward topic – for every buyer, there’s a seller. And because they net out, analysing the size of potential flows is often futile. Instead, the important question is whether investors become motivated to switch to another asset class, displacing existing investors as prices rise (yields fall).
Lower US base rates would reduce the attraction of money markets, but it depends on why the Fed is cutting rates. In a recession, I suspect investors will be happy to stay in money market funds even if the Fed slashes interest rates. So, let’s assume the Fed cuts interest rates as US economic growth slows, but remains positive.
Given elevated US equity valuations and tight credit spreads, it’s not obvious that investors would rush into these asset classes as the economy slows. Instead, investors might consider looking for higher yields or cheaper equity markets abroad. And if enough people do this, you could see the US dollar depreciate, encouraging even more flow in that direction.
Leaving the comfort of the dollar market is not for the faint-hearted, so I’d be surprised if the flow is a large proportion of current US money market assets, but investments like local currency emerging market debt, or perhaps technology-heavy equity bourses in Korea and Taiwan might benefit from even a modest shift.
Michele Barlow, APAC head of investment strategy and research
State Street Global Advisors
As inflation continues to abate, we (and the market) are expecting the Fed to start cutting interest rates in September.
We anticipate a total of three, to possibly, four cuts this year with the Fed continuing to cut next year, reaching a Feds Fund rate of 3.00-3.25% by end-2025 to stick a soft landing.
As investors anticipate rate cuts, we’ve started to see investors shifting out of money market funds into long-term government and global aggregate bonds.
We favour long-duration government bonds over equities given attractive risk-adjusted returns.
Outside of US Treasuries, corporate credit remains less attractive due to extremely rich valuations.
We see more opportunities in emerging markets and structured credit such as mortgage-backed securities (MBS) and commercial mortgage-backed securities (CMBS).
An ongoing decline in the equity risk premium, lofty valuations (especially in the US), and shifting expectations around interest rates could eventually temper enthusiasm for equities.
However, in a soft landing scenario, we would expect some flows to find their way into equities.
In a scenario where the cost of debt falls without impairment to economic growth, the equity market rally could continue to broaden out beyond growth stocks, but we would maintain our preference for higher-quality names.
The US market should remain a key beneficiary over other major markets.
With geopolitical risk remaining front and centre, gold may continue to garner inflows. It has a strong track record of protecting against both short- and long-term market volatility.
Alastair Sewell, liquidity investment strategist
Aviva Investors
The canary in the coal mine is the dollar balance in US money market funds.
Right now, we're in a finely balanced position between increased expectations that rate cuts are finally going to start getting delivered, and the fear that a recession is around the corner.
If you look back in history, after the financial crisis in 2008, there was about a 20% outflow from US money market funds.
Assuming those assets went into the risk markets, if you put that into today's numbers, that would be over $1 trillion flowing into risk assets.
My sense is that for many investors, their first step will be moving into high-quality, short-duration products. I suspect they will begin to add a little duration exposure without taking on too much risk.
Obviously, high yield is a short-duration asset class as well, but it takes more risk. Some investors will certainly go there.
But for me, it'll be that first step out of conservative, low-risk allocations, back into risk market. It is probably going to be the short-duration space, which is going to be super interesting.
Geoff Lunt, head of Asia investment specialists
HSBC Asset Management
Investors are facing a conundrum. Most realise that US interest rates are highly likely to be cut soon and that the great money fund rates they’ve enjoyed since 2023 won’t be around much longer, and may even revisit much lower levels over the medium term.
However, they also know if they buy bonds, which is the most rational thing to protect themselves against falling interest rates, then they will either have to accept lower yields because of the inverted yield curve, or take higher credit risk.
Meanwhile, developed market equity performance has been extremely strong so there may be a rational reluctance to buy more shares, even if it makes sense to maintain some diversification within a balanced allocation.
So, it really is a difficult judgment as to when to switch into longer-duration assets and benefit from lower yields, but we believe that this switch does need to take place at some point in the near future if investors are going to achieve the best outcome.
Over the past couple of months, we have seen much more interest in longer-dated bonds, even if initial moves have been tentative.
One of the approaches we are advocating is maintaining a flexible approach to the management of bond duration by adjusting portfolios according to the progress of the global economy and developments in the market during the rate-cutting cycle.
This should allow skilled managers to target the best-performing part of the yield curve and achieve strong returns.
John Velis, Americas macro strategist
BNY
Interest rates will almost certainly be falling into the end of the year, but how far and how fast is still an open question.
Lower rates will put pressure on funds’ yields; this could lessen their appeal to investors looking for returns.
However, there is more uncertainty heading into the end of the year, so their almost cash-like liquidity will still be valued by institutional investors.
Investors with higher risk tolerance might give up the lower yields and take more duration risk in other portions of the money market, and we expect most US-based investors to stay in US dollar assets.
We think for investors who require more stable returns – even if lower - the liquidity and relative safety of a money fund may still be appealing.
But the fact is that money funds now have around $6.5 trillion in assets under management, a number that has been growing almost inexorably.
With so much cash in the financial system, they play a crucial role in intermediating that cash, offering liquidity, and helping run short-term financial plumbing. They will always be significant fixtures of the financial landscape.
Andy Wong, head of Asia multi asset
Pictet Asset Management
While the market awaits Fed rate cuts, investors are reminded of the opportunity cost of not investing. Our theme this year is focusing on ‘trends not events’.
To us, the number of rate cuts doesn’t matter much. The disinflation trend will endure.
As flows into risk assets increase, we believe a barbell approach will help investors lock in the relatively high real yields in US Treasuries and other high-quality bonds, while capturing the upside from the secular growth through strategic allocation.
The high real yields now are a sharp contrast to 2020-2021, when real yields were negative, but investors piled into bonds.
Now, it is fashionable to worry about the US fiscal deficit, even when we are nowhere near a tipping point.
Meanwhile, we are on the verge of significant tech advancement. Investors need to be exposed to this ‘tomorrow’s beta’.
We see significant opportunities in tech leaders, semiconductor, ecosystems, aggregators, and infrastructure.
While positioning was stretched going into July, it has been reset with the carry trade unwind. Missing out on these opportunities is a very high opportunity cost.