In Federated Hermes' latest monthly update, "Changing the game plan," Global Liquidity CIO Deborah Cunningham writes, "The September FOMC meeting was the latest case of the Federal Reserve moving its policy goal posts. (It's college football season, so allow me some analogies!) In their new Summary of Economic Projections (SEP), policymakers yet again increased the level they think the fed funds rate will reach in the near future. Their median projections rose by 50 basis points from June's forecast to 5.1% and 3.9% in 2024 and 2025, respectively. It's another in a string of dot-plot increases since they finally got serious about inflation roughly two years ago." (Note: Money market mutual fund assets broke $6.1 trillion for the first time ever Tuesday, rising $49.2 billion in the week ended 10/3 to a record $6.108 trillion, according to our Money Fund Intelligence Daily. Prime Retail MMFs surpassed Prime Inst MMFs for the first time since late 2016. Watch for more in Friday's MFI newsletter.)
She says, "It's understandable policymakers wanted to avoid shocking the markets with predictions that rates would have to surge to tackle inflation. But this 'three yards and a cloud of dust' approach has confused investors and traders, leading them to doubt the Fed one month and believe it the next. It has happened again following the September meeting. Despite the new dot plot indicating FOMC members expect to raise the target range by another 25 basis points this year, Treasuries futures have priced in a pause in November, with cuts to follow in the mid 2024."
Cunningham continues, "While rising rates tend to benefit liquidity products, the ever-shifting SEP has often blocked entire sections of the Treasury yield curve from useful trading. That's occurring now. If you believe, as we do, that rates will climb further, value is hard to find along the yield curve. In particular, it has been difficult to find worthwhile trades for securities maturing longer than three months. The yields are simply not high enough. Thankfully, the various prime curves have tracked the Fed better, one of the reasons for the continuing flows into retail prime funds."
She comments, "We are inclined to accept the Fed's message of high-for-longer. A month's worth of data could change our minds. But at present, we expect a quarter-point hike in November and don't envision easing to take place until 2025, or late 2024 at the earliest. The U.S. economy has been exhibiting signs of slowing but not of rolling over. Consumers and workers remain in positions of strength, and goods and services sectors are hanging in there. Inflation is falling, but the closer you get to the endzone, the harder it is to advance. The game is far from over."
Finally, Federated says under the heading, "Money markets funds free at last," "We have been celebrating for two months, but today is the first without the two SEC rules from 2014 that caused so much damage to the money fund industry. The new regulations passed in July removed the potential imposition for redemption gates, as well as the link between weekly liquid assets and potential fees on prime and municipal money market funds. We continue to anticipate retail clients and sweep accounts will return to these products for their attractive yield potential and other advantages."
In other news, BNP Paribas Asset Management's recently posted a "Viewpoint" podcast which discusses money market funds. Daniel Morris says, "Hello and welcome to the BNP Paribas Asset Management Talking Heads podcast. Every week, Talking Heads will bring you in-depth insights and analysis on the topics that really matter to investors. In this episode, we'll be discussing money markets. I'm Daniel Morris, Chief Market Strategist and I'm joined today by Thibault Malin, Investment Specialist. Welcome, Thibault, thanks for joining me."
Morris tells us, "For many markets, in terms of the uncertainties around central bank policy rates, recession (or not), rate cutting (or not) this year has been more challenging than normal. If we think about how money market funds have responded to this environment so far, they've reacted to the rate hikes delivered by the central banks, but the concern is now if and when rates start to decrease, how is that going to affect the performance of money market funds?"
Malin responds, "It is true that money market funds' performance is highly correlated with the rate environment as they are very short-term products. Their rate and credit durations, however, are managed actively, which means that whatever the economic and rate environment, portfolio managers have ways of adding value versus their benchmarks. This is a strength of money market funds. If we look at periods like 2014 to 2016, when the European Central Bank had to cut its rates below zero, money market funds were able to respond to this through active management of their rate and credit durations."
He adds, "We do not anticipate rate cuts in the coming months -- it may happen in 2024. If rates start to fall, we will adapt our investment strategies to seek to continue to outperform our benchmarks, even in a negative rate environment."
Morris then asks, "Alongside predicting what's going to happen with short-term interest rates, there is an entire regulatory framework that affects money market funds. How will that evolve in the months and year ahead?"
Malin comments, "The current regulation entered into force in 2019 and was scheduled for review in 2022. This summer -- one year late due to the geopolitical conflicts that the European Commission (EC) had to deal with -- the EC released its report on the functioning of the money market fund regulation. The idea was to review whether money market funds' liquidity was sufficient to meet all the requirements alongside their rate credit durations. With the challenging environment we have had over the past four years -- the real-life stress test of the Covid crisis, the liquidity crisis in March 2020, the changing policy rate paradigm across the euro, sterling and US dollar, and the credit stress in 2023 after the US regional banks crisis -- the regulators had many indicators to analyse."
He summarizes, "It appears that the regulators now deem money market funds resilient enough to continue to be sold and to perform under the current regulation. More indicators may be added after the end of the current EC presidency at the end of 2024; there could be another review that might add new liquidity requirements for money market funds. But as of now, it seems regulators and asset managers agree that money market funds are extremely resilient."
Morris also queries, "When the central banks do eventually start cutting policy rates, are we likely to see redemptions from money market funds as soon as that starts?" Malin replies, "It is true that money market funds have received subscriptions since we have had positive rates -- in particularly high rates -- but not that much, actually. We had a lot of subscriptions as soon as we entered the positive rate environment at the end of 2022, but this year, from January to August, we had about EUR 70 billion-worth of inflows into European money market funds across all currencies. That is not so high considering it is a market that totals more than EUR 1,600 billion."
He tells the podcast, "Many types of clients, such as insurance companies and asset managers, have subscribed to money market funds for different reasons. They have found money market funds attractive in a situation where we have an inverted yield curve, making it potentially better to invest for the short run as it currently outperforms long-term investments. These investors have started to redeem money market funds over the past few weeks to invest back in medium or long-term assets as we approach the end of this hiking cycle."
Malin continues, "However, it is important to mention that even if policy rates are cut in 2024 or 2025, it is unlikely that we will get back to the rate environment of early 2022, which should mean that money market funds remain attractive in terms of potential performance, even compared to other medium or long-term products, and to all type of clients. In the current environment, we are still seeing many clients with a renewed interest in money market funds, particularly the retail and private banking sectors, where it generally takes more time to adapt to the different economic cycles."
