On the money: why money-market funds are in vogue
As interest rates begin to rise, now may be the time for cash investors to review their strategies. We take a look at what money-market funds (MMFs) have to offer, and where investors can position themselves on the curve.
Since the start of the year, all eyes have been focused on the timing and pace of expected tightening from the Federal Reserve (Fed). The first hike was delivered at the March Federal Open Market Committee (FOMC) meeting, taking the target range to 0.25%-0.50%. Market participants have increased expectations for rate hikes as the year has gone on, with the possibility of some increases being 0.50% in size rather than the more traditional 0.25% hike. The Fed also hinted that quantitative-tightening measures could be announced in May, as it aims to normalise the size of its balance sheet. The tone from the Fed has become more hawkish, in light of persistent above-target inflation, currently at its highest in over 30 years1.
The increase in short-term interest rates and a general flattening of the curve leaves treasurers and cash investors puzzling about where to position themselves. We believe now is a great time for investors to revisit their cash-management strategy to ensure they are optimising returns.
Don’t bank on it
Central-bank liquidity provision following the COVID-19 pandemic left cash in the system at near all-time highs; as a result, bank balance sheets are awash with cheap funding from depositors. But as the beginning of the hiking cycle beckons, if interest rates rise, those who’ve kept their money in deposit accounts could find themselves losing out.
Short and sweet
Offshore US dollar-denominated MMFs hold over $500 billion in assets under management and have seen a large increase over the past decade, as shown in the chart below.
MMFs seek to offer same-day liquidity by investing in a diversified portfolio of high-quality short-term assets, but have been operating in a near-zero yield environment since the emergency cuts to the Fed funds rate in March 2020 due to the COVID-19 pandemic. Now that rates have started to lift off, end investors may benefit from an increased return on their MMF balances.
In previous hiking cycles banks have been slow to pass through increased rates to depositors. This time, the appetite will be even lower due to Basel III rules promoting stable funding and abundant liquidity in the system, so short-term maturities and money market funds may be the sweet spot for cash investors.
Active cash management is now more important than ever, in our view. MMFs might be the missing link when a ‘set and forget’ strategy will no longer do.
1. US CPI YoY: 7.9% as of Feb 2022. Source: bls.gov