Summer doesn’t officially start until 21 June, but Memorial Day in the US marks the opening of public pools. That means municipalities were filling them in May with the clear, shimmering water that beckons children from coast to coast.
Liquidity vehicles experienced their own flows in May (you probably knew I was headed in this direction…). Many lost assets in March and April, but it was largely due to corporate and individual tax dates, not from the beginning of the end of cash’s reign. After two years of its kingly status, some might hope to see other asset classes become more attractive. But money market funds, retail in particular, are only growing in favour as they ride the US Federal Reserve’s reticence to cut rates. Both total industry money funds and total industry retail funds had inflows in May. Modest, but inflows.
Could it be that the pool will overflow? Some media reports have expressed concerns that, due to elevated yields, earnings from money funds have risen to about 1% of US GDP, suggesting the US economy might not be as strong as it seems. Others have pointed to record amount of assets in money funds as a risk if clients reallocate to other investments when the Fed eases.
Money market funds, retail in particular, are only growing in favour as they ride the US Federal Reserve’s reticence to cut rates
The former claim is absurd. Money funds are simply another source of earnings, and consumers continue to spend. The latter argument falls apart when seen in relative terms. Since 2013, money fund assets worldwide have averaged 15-17% of total mutual fund assets and ETFs. At the end of 2023, that figure was 17.3%. For comparison, it was approximately 45% during the height of the Global Financial Crisis. The reasoning that the financial system is threatened by the success of liquidity products is specious. While it is always important to look for stress in the markets, this seems more a case of investor angst. Or maybe jealousy. In any case, we think there’s room for liquidity vehicles to grow, and the expected influx of institutional assets have not begun in earnest yet.
Keeping with the swimming pool metaphor, the US Treasury Department is acting like a drain. On 29 May, it began a programme to buy back a set amount of government securities. My colleague Susan Hill lays this out well in an earlier piece. The gist is that Secretary Janet Yellen and company want to support the US Treasury market by increasing liquidity via purchases on the secondary market. The focus now is on bonds and notes, but Treasury plans on targeting bills to lessen market volatility when it issues fewer short-term securities because it has a surfeit of cash. While it won’t make a ton of difference if the buyback amount is modest, as it has been so far, it can only help cash managers.
Moving target
It would be easier to name the Fed governors and branch presidents who didn’t speak in May than those who did. One gets the feeling that dissent will be coming, especially as the minutes of the May Federal Open Market Committee meeting were more hawkish than the neutral-to-dovish spin Chair Jerome Powell gave in his press conference.
We already know that the three 25bps cuts the US Federal Reserve once pencilled for the second half of this year have been postponed. We expect to get only one or two now. However, the spectre of a rate hike raised its frightful head in the May meeting: “Various participants mentioned a willingness to tighten policy further should risks to inflation materialise in a way that such an action became appropriate.” Despite this warning, we do not anticipate a hike. One thing to note is that the idea that the Fed will avoid cutting rates in September so as not to appear to interfere with the US general election, forgoing rate action when warranted by the data might also look politically motivated. The argument cuts both ways, so to speak.
Liquidity at large
The Swedes joined the Swiss in May when its Riksbank cut interest rates, becoming the second major central bank to do so. It decreased its benchmark rate by a quarter point to 3.75%, the same amount by which the Swiss National Bank lowered its to 1.50% in March. The next domino to fall is likely the European Central Bank, which many think will ease at its meeting on 6 June. Based on the progress the EU has seen in lowering inflation, the markets have priced in a 25bps cut, which would take its benchmark to 3.75%.
The outlook for the Bank of England and Bank of Canada is less certain. The former kept rates at 5.25% in May. Declining UK inflation suggests it will ease at its 20 June meeting, but the markets don’t anticipate it. For the latter, traders have fully priced in a rate cut in July, with the 5 June meeting in play. The Reserve Bank of Australia appears to be wary of an elongated pause in the decline of the country’s inflation and will likely keep rates at 3.35%. The Bank of Japan is likely to take it slow with hikes in case inflation pulls back, though a board member said waiting too long is also a risk.
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