Fed Rate Cut "Futile": Money Funds Still Shun Long-Term US Debt
Despite the Federal Reserve's initiation of a rate-cutting cycle last week with a 50 basis point cut, money market funds are still reluctant to purchase longer-term U.S. Treasury bonds.
When the Fed starts a rate-cutting cycle, fund managers typically buy more short-term U.S. Treasuries to lock in higher yields.
However, the U.S. Treasury yield curve remains inverted, which means that the yield on short-term Treasuries is higher than that on long-term Treasuries, discouraging the flow of funds into long-term bonds.
This is a challenging environment for money market funds.
The money market has been anticipating rate cuts from the Fed, but not as quickly as the broader market currently reflects.
J.P. Morgan strategist Teresa Ho said in a client report: "How the easing cycle will unfold and the inverted yield curve remain unclear."
Data shows that the spread between one-month and one-year Treasury bills is negative by about 82 basis points, and the spread between three-month and two-year Treasury bills is negative by 106 basis points.
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These inversions have led to a shortening of the weighted average duration of fund assets.
Teresa Ho said: "These curves are still severely inverted, challenging the willingness of liquidity investors to extend their duration."
According to J.P. Morgan, government funds, which are major buyers of Treasury bills, increased their holdings of Treasury bills with a maturity of 31 to 60 days by $22.6 billion in August, while reducing holdings of Treasury bills with a maturity of more than 60 days by $5.3 billion.
Meanwhile, prime funds, which tend to invest in riskier assets such as commercial paper, increased their allocation to floating-rate notes from 15% at the beginning of the year to 20% at the end of last month.
He noted that this is because, in the current interest rate environment, floating bonds often provide better protection and ensure higher yields.
Deborah Cunningham, Chief Investment Officer of Global Liquidity Markets at Federated Hermes, said: "Short-term bills are unattractive, making it harder to extend the weighted average duration."
"It's just a matter of closing your eyes and picking the one you like the least."
The uncertainty of the rate cut has increased the difficulty for money market funds to buy longer-term U.S. Treasury bonds.
The interest rate path forecast released last week along with the Fed's monetary policy decision showed that policymakers expect a 50 basis point cut by the end of this year.
Meanwhile, the money market currently expects the Fed to cut rates by about 73 basis points for the remainder of this year.
In addition, both Teresa Ho and Deborah Cunningham believe that the asset size managed by money funds will climb this year.
On one hand, during such periods, institutional and corporate finance executives tend to outsource cash management to earn returns rather than solving problems themselves.
On the other hand, the return rates of these investment tools are still higher than bank deposits.
Teresa Ho said: "Given the still-inverted front-end yield curve, and the yield advantage of money market funds over other cash alternatives, we expect the asset management size of money market funds to continue to rise before the end of the year."