J.P. Morgan published its "Short-Term Fixed Income 2024 Outlook" last week, which is entitled, "More of more and less of less." Authors Teresa Ho, Pankaj Vohra and Holly Cunningham tell us, "In contrast to the long end of the Treasury curve, it was a remarkably stable year in the money markets. Despite the regional banking crisis, massive T-bill issuance, finalization of MMF reform, all the while with QT going on in the background, spreads in the money markets traded mostly in a narrow range. That stability underscored the abundance of liquidity still in the financial system, most of which seemed to be sitting in the very front end. Indeed, MMF AUMs grew by nearly $1tn this year, with balances currently registering $6tn, as investors could not ignore the 5% yield on an overnight asset, a dynamic we haven't seen since 2007. To be sure, markets have made use of that liquidity, as Fed ON RRP balances declined by a substantial $1.3tn. It helped too that the Fed was nearing the end of its tightening cycle, giving MMFs a reason to rotate out of the facility and into T-bills. As of the time of writing, usage at the Fed ON RRP has fallen below $1tn.." (Note: JPMorgan's Pankaj Vohra will present the "Instruments of the Money Markets Intro" at our upcoming Money Fund University, which is Dec. 18-19 in Jersey City, NJ.)
The 2024 Outlook explains, "2024 could prove slightly more interesting for the money markets. With the Fed expected to be on hold in 1H and cut in 2H, the demand for MMFs with 5% yields should persist. While investors might extend from cash into duration, we suspect overall flows will continue to keep MMF AUMs elevated. Meanwhile, money market supply is expected to grow meaningfully again, driven by T-bills. Repo volumes are also biased higher as markets try to absorb an additional $2tn of Treasury coupon issuance. Importantly, the combination of T-bill and repo supply should help RRP continue to drain."
It says, "But while 2024 might look like a repeat of this year, it is another year of less liquidity, more T-bills, more Treasury coupons, more repo. Markets' capacity to absorb additional supply is somewhat more limited now compared to a year ago. At the same time, there is a growing consensus that the SEC is looking to finalize its proposal to centrally clear Treasuries and Treasury repo soon, which should increase the overall costs of trading. Furthermore, a recent report from FHFA proposes to overhaul the FHLB system, which should not only reduce the amount of FHLB supply but also increase the demand for bank reserves and alternative sources of funding among domestic banks."
They continue, "All told, we see nearly $875bn worth of T-bills and repo supply in 2024, coming on the heels of over $2.1tn issued this year. While demand from money market investors should persist, prices might need to adjust to incentivize continued absorption of that supply, particularly as RRP liquidity continues to decline. As a result, we expect T-bills/OIS spreads to cheapen on the margin. CPCD/OIS spreads will likely trade in a narrow range, with a cheapening bias. Both T-bills/OIS and CPCD/OIS spread curves should flatten. Absent a liquidity shortage, we expect the EFFR/IORB spread to remain at current levels, with a bias that it trends higher as we approach LCLoR in late 2H24. Increases to repo supply should bias SOFR higher, and especially if the Treasury clearing rule is finalized. Net, SOFR should trade higher relative to EFFR."
J.P. Morgan comments, "Against this backdrop, the Fed is likely done hiking for this cycle. We expect rates to be on hold through 2Q24, followed by 50bp of rate cuts per quarter beginning in 3Q24, until rates reach a terminal 3.5% in 2Q25. This outlook largely reflects our view that the Fed is unlikely going to return the funds rate all the way down to their estimate of neutral if inflation stays above 2%. Instead, we see the Fed returning to the mid-1990's strategy of 'opportunistic disinflation,' relying on modestly restrictive policy and external events like favorable supply-side shocks to finish the job."
The Outlook states, "If we are right, rates should stay above 5% for the better part of next year, and as such, cash will likely remain an attractive asset class. This was certainly evident in the demand for MMFs this year, as taxable MMF AUMs increased by over $900bn YTD and currently stand at nearly $6.0tn. This marks the greatest increase since 2012, as the regional banking crisis in March, alongside an inverted yield curve and negative returns in riskier assets, all contributed to the impressive rise in MMF balances this year."
It continues, "Arguably, there is some expectation that cash will rotate into longer-duration fixed income next year. Asked whether market participants are looking to reduce, maintain, or add exposure to various asset classes, our client survey reveals that the majority of survey respondents intend to add duration next year. Meanwhile, survey respondents on net look to slightly reduce their cash/money markets exposure."
J.P. Morgan says, "We think a meaningful shift from cash to fixed income is unlikely and that MMF AUMs will remain elevated next year. Indeed, a look at MMF flows going back to 1995, spanning over three easing cycles, shows that MMFs continue to see inflows even as the Fed is on hold and/or begins to cut rates. Intuitively, this makes sense, as MMF yields tend to lag yields of direct cash alternatives such as T-bills when the Fed begins to cut rates, thus attracting flows from other liquidity alternatives. A look at MMF flows versus changes in the curve shape show similar results. That is, flows into MMFs tend to continue even as the curve begins to disinvert/steepen; it's not until the curve more or less stabilizes that outflows begin to take place."
They state, "Furthermore, most market participants use MMFs for cash management/liquidity purposes rather than as an investment asset class as part of one's overall investment portfolio. Accordingly, this should limit the amount of cash pivoting into riskier asset classes. Nor do we think the cash will pivot into bank deposits, even as banks raise their deposit betas. Banks still do not want non-operational institutional deposits on their balance sheets. All told, we do not anticipate the relative value of MMFs versus deposits, short-term bond funds, equities, etc. to change dramatically in the near future. While there might be some rotation out the curve, we suspect the magnitude will not be as meaningful as the inflows seen this year. Overall, MMF AUMs are likely flat with a slight bias lower next year. At a sector level, most of the cash will likely remain in government MMFs versus prime MMFs; if anything, MMF reform should continue to bias government MMF AUMs higher."
The article adds, "It's also worth noting that local government investment pools (LGIPs) will likely remain large liquidity investors in the money markets. Over the past few years, this investor base has grown meaningfully as they benefited from Covid-related fiscal packages. While the law mandates that the Covid-related funds must be obligated by the end of 2024 and spent by the end of 2026, we suspect this is not on an immediate basis but rather will be spent over several quarters.... All told, the attractiveness of the front end, in combination with some of the Covid cash remaining in their portfolios, should help LGIPs maintain their presence in the money markets, even if the size of their investment portfolios likely peaked this year."
Finally, they comment, "We forecast total money market supply to increase by around $1.2tn or 7% in 2024, driven largely by T-bills. Within that, credit supply should rise by ~$350bn or 12% in 2024, driven by credit bonds rolling into the money markets and slightly higher CP/CD net issuance. If we're right, total supply balances will be above their 3y averages, which will likely contribute to draining liquidity from the Fed's ON RRP facility."
