Federated's Cunningham on MMF Lag
Federated Hermes Deborah Cunningham writes, "Slow and steady: When the Fed lowers rates, liquidity yields often decline more gradually than those in the direct market" in her latest monthly commentary. She says, "Another September rate cut and another reason to consider liquidity products. Common sense would say that when the Federal Reserve lowers its benchmark fed funds target range, as it did by a quarter percentage point two weeks ago, that interest rates and yields across the board would fall in concert. But finance doesn't always operate the way it seems it should (who isn't confused when first told that a bond's price falls when its yield rises). It is true that yields of securities in the direct market, such as government auctions, overnight trading and floating-rate securities, adjust quickly to changes in the fed funds level, now in a target range of 4-4.25%. But that's not the case for many financial products, such as mortgages and money market products. Mortgage rates key off the 10-year Treasury; money market portfolios use a 'laddered strategy.'" The brief continues, "In a falling-rate environment, 'laddered' simply means money market portfolios hold securities of different maturities bought with the higher rates available before the Fed cut. This in turn typically causes yields of these portfolios to decline slower than those found in the direct market. That can make them attractive to investors, and accounts may see inflows. It was the case last autumn and true so far this year. As of Monday, the total industry has experienced inflows of around $55 billion since the Fed action, according to iMoneyNet." Cunningham adds, "I am happy to report that ... money market fund assets [domiciled in Ireland] have passed $1 trillion, a record according to Crane Data. That's following the same pattern of growth amid falling rates. Despite the fact that the European Central Bank has taken its deposit rate to 2%, it would seem money funds are similarly becoming more attractive.... Supply and demand is another important factor in the calculation of money market yields. That's especially the case with commercial paper held by prime money funds. The amount of issuance continues to grow, largely resulting in higher yields and wider spreads above similar maturity Treasurys. And this market is becoming more diverse, with tech and manufacturing companies issuing short-term paper in addition to the bread-and-butter financial services sector. Diversification is a key element of money funds, so this is a notable development."
