After three banner years, what can we expect from the broad liquidity markets? In the US, industry money market assets alone have increased more than US$2tn since the Federal Reserve raised rates off the lower bound in March 2022 as yields rode the Fed hikes to reach their highest level in decades. Many pundits think this good fortune will end in 2025 as the central bank has pivoted to easing. We don’t.
Defying gravity: Money market flows vs Fed Funds rate
For one, cash managers construct liquidity portfolios with securities maturing as far out as a year. In a declining-rate environment, these portfolios often have higher yields than the current Fed target range. In theory, this would slow the decline of portfolio yields higher for longer, keeping liquidity products attractive. The latter seems to be happening. Since the Fed cut rates by a half-point in September, US$300bn of assets have flown into money funds.
Two, while thrilled at the returns they’ve garnered since that first hike, few investors in the liquidity space forget about the decade of yields near zero. Many will be more than happy if the Fed’s terminal rate hovers around 3.5%, especially those who use cash primarily as a tool to pay expenses and other needs. That’s why we don’t buy the narrative that investors are chomping at the bit to deploy all their cash to stocks and bonds as yields decline. Liquidity is king.
Three, the Fed is likely to view many of the second Trump administration’s campaign promises—such as cutting taxes, spending more, closing borders and enacting tariffs—as inflationary. Policymakers might respond by slowing the pace of easing, potentially keeping liquidity yields higher for longer.
We think the industry needs to make space in the rafters next year to hoist yet another banner.
Further themes that will matter next year:
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