Federated Investors recently published a new "Here & Now" Podcast entitled, "Cash is king ... again." In the discussion, Federated Senior VP & Senior Equity Strategist Linda Duessel interviews Deborah Cunningham, Federated's CIO for Global Liquidity Markets. She discusses asset inflows, money funds vs. deposits and ESG issues. Duessel says, "Debbie, Liquidity Products saw record inflows in this year's second quarter. What drove that growth?" Cunningham answers, "Well, there were three major reasons, Linda. First of all, interest rates are no longer at zero, so this has made cash an asset class again. Ultimately when we went through the decade of zero interest rates, people used cash because they needed to have liquidity for daily, weekly, monthly purchases. But other than that, it really wasn't something that was allocated because of the low return associated with it. But given that we no longer have those [ultra-low] interest rates and we're at interest rates that are in the 2% range, that has worked well as a safe harbor to some degree for those that are allocating."
She continues, "Money market rates also look very good versus other short term liquidity alternatives, especially deposit products. When you look at deposit betas, it's essentially the rate of change for bank deposit products versus what's happening from a rate of change in a markets rate basis. It's as low as it's ever been in a rising rate environment. Granted, we may be ending that rising rate environment now, but nonetheless, at 29%, that essentially means for every hundred basis points that the Fed raised, deposit products went up by 29 basis points. That's the institutional side of things. The retail side of the market is even worse."
Cunningham explains, "Ultimately, we've had very good growth because of the comparison to ... deposit products. When we're looking at overall rates now, you're looking at something that from a government product standpoint in money market funds, it's about a 215 to 220 [bps] gross yield. Prime products are 233 to 235. Even when you're looking at tax frees on the muni side of the equation, [you're talking about] 140 to 150. All of which are much, much higher than those [on] deposit products."
She comments, "The third major reason is basically what I mentioned before, that liquidity products, money market funds in particular, have been a safe haven in quite volatile times. If you go all the way back to 2018, it was the only one of the three major asset classes that actually had a positive return. And with all the global issues and uncertainty ... all of these things I think came to a crescendo in the second quarter and allowed people to take a safe haven approach, which put them into the liquidity markets.... Cash is looking pretty good. Even when we're looking at other types of fixed income securities."
When asked about falling rates, Cunningham responds, "The Fed lowered rates by 25 basis points in July.... If you look at our yields now in the money market industry, there are 25 to 35 basis points lower than where they were in the end of the first quarter, which is when the adjustments in the marketplace began to ring through.... Ultimately, if the Fed lowers rates by another 25 or 50 basis points, you're going to see a same direct impact with about a month to six weeks sort of lag."
She tells Duessel, "The asset growth has been tremendous. So when we look on an industry basis at total prime assets over the course of the last year, ending at the end of the second quarter, June 2019, the industry has had a 42% growth rate. Federated assets in the prime sector, [are] up 55%. Government assets, on an industry basis, [are] up 8%. Federated's government assets up 21%. And on the muni, side industry is only up 1%. But Federated's up 25%.... Ultimately, I think from a yield perspective, the market grew lazy once interest rates went below 1% and ... cash no longer proved to be an asset allocation tool at that point."
Comparing money market funds and bank deposits in a declining rate environment, Cunningham says, "Because of that deposit beta and banks' lack of moving interest rates up over the course of the last two and a half years in the increasing rate environment, the markets had begun to move away from bank deposit products. Bank deposit products were the place to be in the financial crisis. In 2008, 2009 they were 100% guaranteed for a period of time, and the markets flocked to them.... It wasn't until the Fed started raising rates at the end of 2016 that you actually started to see that reverse. Now at this point, you see deposits [growing] somewhere in the neighborhood of 2% to 10% over the last one to three years, versus money market funds (growing) anywhere from 10% to 20%.... In a declining rate environment, that will even grow larger, because the banks have already lowered their rates."
Duessel also asks Cunningham about ESG. She answers, "[B]eginning in 2019 ... we began to integrate the information that we receive from our Hermes counterparts ... into what is basically the qualitative assessments that our investment analysts do [on our] minimal credit risk, high quality determinations.... What we haven't done yet at this point is begin a named ESG money market fund. We may, we may not. It will be driven by client requests, essentially. I think at this point when we see what's happening from our own client standpoint, the ESG assessments and integration are being driven by the coastal clients. So East coast, West coast, both have what seems to be more of a unique interest and need in understanding how environmental, social and governance aspects impact our credit analysis process."
In related news, Federated's Cunningham also writes in her monthly commentary about, "An intriguing development at the Fed." She comments, "Is dissent forming in the Federal Reserve? The markets are convinced policymakers will cut rates at the September Federal Open Market Committee (FOMC) meeting, but they'd be wise to re-read the bottom of the July meeting's statement that said 'Voting against the action were Esther L. George and Eric S. Rosengren, who preferred at this meeting to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent.'"
Cunningham continues, "In the meantime, cash managers -- really everybody -- can only deal with what is in front of them. The global rush to the haven of Treasuries caused the curve to fluctuate (although the U.S. Treasury's massive issuance of bills and notes kept it within a reasonable range). But with the Treasury and Libor yield curves fluctuating in August, we had to be very selective in our purchases. On any given day, the best offerings were vastly different than the day before. Some days, the 3-month area looked attractive; other days, 6-month paper stood out. Floaters continued to be a crucial part of our book of business, with spreads widening out, if only slightly. We did not alter our weighted average maturities (WAM) of 30-40 days for government funds and 40-50 for prime and muni funds. But we were able to move the actual WAMs longer within those ranges."
Finally, she adds, "Some unequivocal good news is that all sectors of the liquidity space on an industry-wide basis continued to take in flows. In August, the industry reached the highest amount of assets under management (around $3.6 trillion) since the peak of 2007 ($3.9 trillion). That is pretty amazing, especially for prime funds that many left for dead after reform. And how about this nugget: industry-wide, flows into prime funds in the second quarter of this year numbered more than total assets in the space immediately after reform."
