Investors are grappling with a substantial cash reserve in money market funds, now totaling approximately $7.6 trillion, according to Crane Data. This unprecedented amount raises concerns about how these funds will react when the Federal Reserve begins to cut interest rates. With average annual earnings standing at 4.3%, many investors are pondering the implications of potential rate reductions on their investments.
Peter Crane, president and publisher of Crane Data, acknowledges that interest rate could fall to 3%. He thinks a lot of this cash will likely remain in money market funds. Maturity profile These funds have a weighted maturity of 30 days. This means they will generally take a full month to completely adjust to rate changes.
Historically, the money market fund sector has seen asset declines only during two major economic downturns: the dot-com bust and the financial crisis. In historical context, this would suggest that the market will not immediately react in anticipation even after the Fed has made its decision to cut. This creates another layer of uncertainty for investors.
Today, there has been a marked demographic change in the appearance of money market funds. In fact, institutional and corporate cash now makes up about three-quarters of the market. This shift raises questions about how retail investors, who often leave about $20 trillion in bank deposits earning no interest, might respond to evolving market conditions.
According to Todd Sohn, a strategist at the investment firm Strategas, portfolios should be more exposed abroad than they are right now. He advises pension and institutional investors to ramp up their equities allocation. Or they might invest in treasury exchange-traded funds (ETFs) with two- or five-year durations.
“But perhaps you see holes in your equity sleeve,” – Todd Sohn
A 25-basis point reduction in interest rates does not render money market funds redundant. It certainly adds to the difficulty of the decision for yield-seeking investors. According to Sohn, the volatility in the fixed-income market is getting increasingly bad. Consequently, investors may end up assuming greater duration risk and not assuming greater credit risk.
Crane’s quip points to something bigger — that rate increases or decreases don’t have as much effect as they are often assumed to have.
“The rates matter but much less than most people believe,” – Peter Crane
He goes on to claim that once rates approach zero, money market funds might start to lose investors. This erosion in the investor base might be more consequential. For the past several months, there has been swelling concern that yields on these funds would soon fall into the dreaded low-3% range. If they succeed, it may take a toll on their after-tax yield attractiveness.
For investors still deciding where to place their bets, equity vs. fixed income isn’t the only portfolio consideration.
“Assess your portfolio to see if you need small-, mid-cap or international exposures. There are a ton of low cost options for this,” – Todd Sohn
Crane is not alone in feeling this way. A $5,000 money market fund earning 1% or 2% isn’t even really investment—it’s more of a savings account, and Dunn recommends looking for better investment opportunities here.
“You just spent more money thinking about the problem than you are earning. Nothing is worth doing for less than 1% or one hundred bucks,” – Peter Crane
The new economic reality creates a precarious situation for Main Street investors. The wisdom of those cuts patchy mainstreetment. They must reimagine their business models and learn to flourish in a world focused on cash.