In the liquidity space, the first quarter of the year typically sees outflows due largely to a reversal of year-end window-dressing, the corporate tax date on March 15 and preparation for individual tax payments in April. Not so this year. Total industry money market fund assets under management (AUM) held firm at around US$7.45tn (iMoneyNet figures).
What accounts for the difference? Lower tax payments due to the One Big Beautiful Bill likely played a role, but logic would point you to the US and Israel’s attack on Iran. Nothing curtails risk-taking more than political turmoil. In these situations, investors – especially institutional ones – often adjust their portfolios to increase the percentage of liquidity or stable value products. This is not ‘hot money,’ but these investors usually keep their coats on, expecting to leave as soon as things calm down.
Yet the Iran conflict only accounted for one-third of the first quarter. Substantial assets poured into liquidity products in January and February, pushing industry money market assets to all-time highs in the week just before the attacks. Thankfully, the reason for this was positive – the attractive yields stemming from the elevated fed funds rate. For an asset class designed to seek stability of principal and ease of redemption, yields are still a main variable. The US Federal Reserve (Fed) raised its benchmark rate so aggressively in 2022 to counter spiking inflation, that even two years after it pivoted to easing, the target range is still attractive. In other words, cash is an asset class – gaining favour on its own merits, rather than a counter to geopolitical upheaval or anxiety over stocks.
So the question is what happens when investors think the geopolitical environment has improved enough to rotate back to riskier assets like the stock market?
So the question is what happens when investors think the geopolitical environment has improved enough to rotate back to riskier assets like the stock market? Tradition says they will do just that, either looking to buy low or participate in the economic growth many analysts think will follow the conclusion of the Iran conflict. Some surely will. But we think some of the investors will be warmed by the current yields of money funds, take off their coats and stay awhile.
Time will tell, but the twist is that the war is likely to keep Fed policymakers on the sidelines longer. The December dot plot only projected one additional quarter-point cut this year, and that didn’t halt the inflows. If the spike in oil prices causes inflation to do an about face, it’s unlikely the Fed will move at all this year. If that keeps market-based money market yields close to where they are now, appetite should remain.
Political baseball
The saying in the US is political football, but the Major League Baseball season has begun, so we are going with that. The drama surrounding the Fed has taken a back seat to coverage of the Iran conflict, but little progress has been made. In mid-March, a federal judge dismissed the Department of Justice (DOJ) probe of Fed Chair Jerome Powell, but the US attorney for Washington, D.C., said she would appeal. That overhang is preventing the Senate banking committee from sending Trump’s nominee successor, Kevin Warsh, to a confirmation vote. Powell addressed the situation again at the March Federal Open Market Committee meeting, following the same strategy he used when the DOJ served him a subpoena in January: be aggressive once and then ignore it. In the press conference, he announced his intention to serve as chair pro tempore until the Senate confirms his successor, pointing to precedent and saying “That is what the law calls for.” He also said he will stay on the Fed’s Board of Governors until the DOJ probe is “well and truly over.” It’s unclear if this decision also applies to the investigation into Governor Lisa Cook, but we believe that probably is the case.
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