International Monetary Fund Economist Kleopatra Nikolaou published a Working Paper titled, "Money Market Fund Growth During Hiking Cycles: A Global Analysis," which tells us, "This paper examines the drivers of money market funds (MMFs) growth during monetary policy hiking cycles. Analyzing data from nine countries with notable MMF sectors post-pandemic, it examines three main drivers: yield differentials between MMFs and bank deposits, banking turmoils that affect perceptions of relative safety for traditional cash options, and structural characteristics (types) of MMFs. The findings indicate that MMFs attract capital during rising interest rates driven primarily by yield-seeking behavior. This pattern persisted following the 2023 banking turmoil, particularly in the U.S., where yield remained the dominant driver. After accounting for yield differentials, MMF growth was not unusually high compared to previous hiking cycles, suggesting limited evidence of widespread flight-to-safety flows. Moreover, when MMF yields rise, investors in the US and the euro area increasingly favor private debt MMFs, likely due to their higher yields. The study underscores the trade-off between safety and yield in investor behaviour, providing insights for policymakers on enhancing financial stability." (Note: Crane Data's Peter Crane will join AFP's Tom Hunt, Invesco's Laurie Brignac and Masco's Marcel Santiz on a webinar Tuesday (7/29) from 3-4pm ET titled, "Liquidity in Flux: Insights from the 2025 AFP Liquidity Survey.")
It states, "This paper investigates the dynamics behind the growth of money market funds (MMFs) during the global monetary policy tightening cycle of 2022–2024. While past studies have focused on MMF vulnerabilities during systemic crises, recent developments—particularly rising interest rates, widening yield differentials, and the 2023 banking sector stress—have shifted the focus toward MMF inflows. The increase in MMF investments, especially in the U.S., highlighted the dual role MMFs play as yield-enhancing and liquid cash alternatives."
The paper says, "We examine MMF flows across nine countries with significant MMF sectors, focusing on three drivers: (1) the MMF yield advantage over bank deposits, (2) the impact of the 2023 banking turmoil, and (3) the structural composition of MMFs, particularly the split between public and private debt holdings. Our analysis is novel in its international scope and in its focus on MMF behavior during inflow periods."
It explains, "The motivation for these drivers is supported by previous literature and recent experiences. MMFs typically offer higher yields to their investors compared to what banks can offer to depositors during periods of monetary policy tightening. Greater yield differentials between MMFs and bank deposits can enhance MMF growth, as yield oriented investors shift their funds towards MMFs. Additionally, a loss of confidence in banks, resulting from banking turmoil such as that experienced in March 2023, can redirect capital towards MMFs, highlighting the importance of safety in cash management. Finally, MMFs are structured in various ways to accommodate different investor preferences regarding safety versus returns, while still maintaining their role as short-term safe assets."
Nikolaou writes, "Our findings show that the MMF yield advantage is a central factor behind MMF growth, particularly during periods of monetary tightening. Investors respond strongly to yield differentials, reallocating from bank deposits to MMFs when the return gap widens. This pattern was evident across countries in our sample, although the scale of response varied by region. Moreover, we find little evidence for a panic-induced inflow into MMFs in the wake of the 2023 banking turmoil. While in some jurisdictions (i.e. Europe) the effect was overall muted, in others, including the US, MMF inflows were driven more by return-seeking behavior than by panic or risk aversion. Finally, a rise in MMF yields can influence the allocation between public vs private MMFs, in different ways across countries."
She tells us, "Overall, the paper shows that MMFs play a growing role in global cash management, with implications for financial stability and monetary policy. The sensitivity of MMF flows to interest rate changes suggests that monetary tightening can accelerate deposit outflows from banks, complicating policy transmission. At the same time, the limited response to non-systemic banking shocks implies that MMFs primarily serve as instruments of yield optimization in the current financial environment. These findings underscore the importance of MMF design and regulation in managing liquidity risks in an evolving macro-financial landscape."
The IMF piece then says, "In recent years, the dynamics of money market fund (MMFs) flows have returned to the spotlight. While past scrutiny largely focused on MMF outflows during systemic crises, recent attention has shifted toward their inflows -- particularly during episodes of monetary policy tightening. This shift became especially relevant as central banks globally embarked on aggressive rate hikes in 2022–2024 following the pandemic."
It continues, "The tightening cycle revealed growing fragilities in the banking sector, as demonstrated during the 2023 turmoil involving the collapse of U.S. regional banks and Credit Suisse in Europe (Copestake et al., 2023; Jiang et al., 2024). Moreover, a significant yield differential emerged between MMFs and traditional bank deposits, likely prompting many investors—especially yield-sensitive ones -- to reallocate capital away from bank deposits and into MMFs. The surge in MMF inflows, especially in the U.S., raised concerns over deposit stability and underscored the attractiveness of MMFs as both yield-enhancing and liquid cash alternatives."
The report then tells us, "This evolving landscape highlights two fundamental drivers of MMF flows: the search for yield and the desire of safety. Different MMF types have evolved to cater to different combinations of these preferences, yet the behavior of investors during inflow phases -- particularly outside the U.S. -- remains underexplored. We note, however, that these motivations are not always aligned. During periods of outflows, MMF investors may prioritize capital preservation, while during inflow periods, the relative return on MMFs becomes a stronger draw."
It states, "This paper presents evidence of the latter motivation. This paper analyzes MMF growth across a panel of nine countries with sizable MMF sectors that experienced post-pandemic rate hikes. It focused on three main drivers: First, the MMF yield advantage -- the yield gap between MMFs and alternative cash investments such as bank deposits -- as a proxy for investors' desire for higher yields (the return incentive). `Second, the effect of the 2023 banking turmoil, which can undermine confidence in the banking system and redirect flows towards perceived relative safety, in our case MMFs. Third, the structural characteristics of MMFs across jurisdictions, particularly the public vs. private debt composition, which may condition investor sensitivity to risk and return. To our knowledge, this is the first study to systematically examine these three elements in an international context."
The IMF paper continues, "While existing literature supports the idea that yield advantages can drive flows into MMFs, this has not yet been tested. Work by Dreschler et al. (2017) and Xiao (2020) indicates that deposit outflows from banks into MMFs increase during tightening cycles. A key mechanism driving this shift is the opportunity cost of holding bank deposits, which tends to rise during monetary policy tightening periods. This opportunity cost arises as banks are typically slower to pass on higher rates and results in a yield differential—what we term the 'MMF yield advantage' or 'MMF spread.' Rather than attempting to explain this gap, we take it as a given and construct a proxy for the MMF spread across a global panel of MMFs to examine its effect on MMF growth across countries."
It says, "Second, our results do not suggest a flight of investors to MMF safety following the US banking turmoil. Although the 2023 turmoil coincided with heightened financial stress, we find that MMF dynamics were shaped more by MMF superior returns than by pure risk aversion: With few exceptions (notably the Americas region, excluding the US), MMFs did not experience larger growth post turmoil compared to previous hiking cycles, once the role of spreads and macro/fund controls are accounted for. However, our results reveal that investors in certain regions, notably the US, 'woke up' to the higher interest rates offered by MMFs. In those jurisdictions investors moved to MMFs when they became more attractive on a yield basis. Results also reveal regional differences, with the euro area showing little change post pandemic in both average inflows and sensitivity to the MMF spread. The differences are indicative of different investor dynamics and fund structures."
The paper adds, "The MMF sector is present in a relatively limited number of countries, notably AEs, with the US having the largest sector. In December 2023, Advanced Economies, held the more than 75 percent of the total MMF value globally, while China made up the vast majority of MMFs in Emerging market economies.... In terms of nominal size, the US has by far the largest MMF sector globally with just short of $6 trillion assets under management at the end of 2023. At that time MMFs in Europe and in China were less than half the size of US MMFs, around $1.5tr in each region. Beyond Europe, China and the US, countries with notable MMF sectors include Australia, Korea and Brazil."
They state, "In conclusion, our analysis highlights the MMF yield advantage as a primary driver of MMF growth. This advantage typically emerges during monetary policy tightening cycles and has supported MMF inflows following the 2023 banking turmoil. While the 2023 banking turmoil itself did not appear to catalyze MMFs flows, we provide evidence that rising MMF spreads were driving growth at the same period in certain jurisdictions including the US. We also find that a rising MMF yield advantage can determine allocations to different fund types. In the US and the euro area investors shift towards private debt MMFs notably when MMF spreads rise, while outside these two areas the preference is for public MMFs. We also demonstrate a preference for USD-denominated MMFs in several jurisdictions outside the US, which underscores the importance of USD as a safe-haven currency in international finance. These findings provide valuable insights into the factors influencing MMF growth and investor behavior in different MMF jurisdictions during hiking cycles."
Finally, Nikolaou writes, "The findings of this paper carry policy implications for regulators and central banks as they navigate the complexities of money market fund (MMF) dynamics in a shifting economic landscape. The sensitivity of MMF flows to interest rate changes suggests that monetary tightening can accelerate deposit outflows from banks, complicating policy transmission and financial stability. Our paper suggests that, in major countries, large and private debt MMFs will grow further in size and can impact the monetary policy transmission mechanism, which traditionally works through bank deposits. At the same time, the limited response to non-systemic banking shocks implies that MMFs primarily serve as instruments of yield optimization in the current financial environment. These findings underscore the importance of MMF design and regulation in managing liquidity risks in an evolving macro-financial landscape. Regulatory frameworks should ensure that MMFs maintain adequate liquidity and risk management practices. In addition, more transparency regarding MMF yields compared to banks and the inherent risks associated with different fund types may help investors to make more informed decisions, thus supporting financial stability. As the landscape of cash alternatives continues to evolve, ongoing monitoring and adaptive regulation will be essential to safeguard the integrity of both MMF markets and the broader financial system."