Aviva's Outlook for European MMFs
U.K.-based Aviva Investors recently published a "Liquidity Outlook 2024," entitled, "Rates, regulation and the dash for cash," which comments on the environment for European money funds in US dollars, euro and pound sterling. They tell us, "Alastair Sewell answers the seven key questions on the minds of liquidity investors heading into 2024." It states, "The next 12 months presents liquidity investors with something of a conundrum. Nevertheless, we remain constructive on the asset class. Strategically, cash yields look set to remain high; not only high, but above inflation to offer positive real yields. The diversification and high credit quality liquidity funds offer can mitigate adverse economic effects. The prospective combination of low risk and inflation-beating returns may give capital allocators pause for thought. In particular, the prevailing wisdom over the last 15 years of abundant central bank liquidity providing support to risk assets could come under question. Tactically, the 'option' value of cash is likely to remain high in 2024, offering investors the liquidity they need to deploy effectively into markets. In this Q&A, Alastair Sewell, liquidity investment strategist, answers the key questions we are getting from clients." The piece asks, "What will happen to liquidity funds if rates start to fall?" Sewell answers, "Rate cuts are priced in across markets, although there is uncertainty on the pace and magnitude.... However, the amount of cuts the market expects is limited: we expect the long-term interest rate environment will be very different to the period following the Global Financial Crisis. Market forecasts indicate interest rates falling to around 4.5% in sterling, 2.5% in euros and 4.25% in US dollars in 2024. For reference, these levels are relatively 'normal' by historical standards -- the long-term averages in the UK and US are 5.23% and 4.83% respectively. Money market fund (MMF) yields will inevitably settle to the lower level driven by central bank rates. However, we expect a substantial lag between rate cuts and MMF yields decreasing due to funds' ability to actively manage exposures. By buying longer-dated, higher-yielding securities, MMFs can slow down the rate at which they re-invest into newly issued lower-yield securities. History shows MMFs can deliver on this objective effectively. For example, there was a ten–11-month lag between rates being cut below zero and MMF yields turning negative in 2014-15. Standard MMFs are structurally better equipped than short-term MMFs to delay the effect of falling rates. These funds can invest over a longer time horizon and, all else being equal, are better able to lock-in higher-yielding securities for longer. We expect investors to increasingly use blended liquidity strategies in this environment, splitting investment across short-term and standard MMFs to benefit from higher yields while preserving a low aggregate risk profile." Finally, Aviva asks, "Will the 'dash to cash' continue?" They tell us, "MMF assets achieved record highs in 2023. In the US, assets reached $5.8 trillion as of end-November 2023. In Europe, we estimate assets reached $1.75 trillion, based on Lipper data. In our view, a lot of this money will stay in MMFs, if not grow further. In the context of febrile market conditions and high interest rates, MMFs will remain attractive for many investors as a real yield-generating and liquid safe haven."
