Money-Market Funds Stay Popular Amid Fed's Rate Cut Caution

Fed's cautious rate approach aims for economic balance, as money-market funds grow to $6.5 trillion amid rate cut speculations.

By Athena Xu

4/3, 17:21 EDT
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Key Takeaway

  • Despite potential Fed rate cuts, investors prefer staying in money-market funds, earning ~5%, amid uncertain rate cut timing.
  • Wall Street's initial forecast of up to seven 2024 rate cuts revised down to three or fewer, keeping Treasury market volatility high.
  • Money-market funds remain attractive due to slow pace towards rate cuts; equities advanced nearly 10% in Q1, but caution advised.

Fed's Cautious Rate Cut Approach

The Federal Reserve's Chairman Jerome Powell emphasized the central bank's slow and deliberate approach towards cutting interest rates, highlighting the balancing act of managing inflation while supporting economic growth. Despite inflation easing, it remains above the Fed's 2% target, leading to a steady policy rate between 5.25% and 5.5%. This cautious stance stems from the risk that premature rate cuts could halt or reverse progress on inflation, potentially harming the economy. Powell's comments at Stanford University underscored the Fed's priority on doing "the right thing" for the economy over time, without rushing into rate reductions.

Money Markets: The Safe Haven

Amidst the uncertainty of rate cuts, money-market funds have become an attractive option for investors, offering roughly 5% returns. The appeal of these funds has grown, especially as the Fed's rate hike cycle led to a significant shift of deposits from banks to money markets, with assets swelling to a record $6.5 trillion. This shift was partly driven by the collapse of Silicon Valley Bank, prompting investors to seek higher yields and safety outside the traditional banking system. Despite Wall Street's initial expectations of multiple rate cuts in 2024, predictions have been scaled back, reflecting the unpredictability of the Fed's actions and maintaining high volatility in the Treasury market.

Investor Strategies in Flux

Investors are navigating the changing landscape with varied strategies. Some, like Dafina Smith, are moving from cash products to stocks, capitalizing on the S&P 500's significant gains. However, the transition from high-yield cash investments to other asset classes is not straightforward. Financial advisers caution that high-yield savings rates may adjust first when the Fed cuts rates, followed by Treasury bills and CDs. This creates a complex decision-making environment for investors, who must carefully consider the term and yield of their investments in anticipation of future rate movements.

Street Views

  • Jerome Powell, Fed Chairman (Neutral on interest rate cuts):

    "If you cut too soon," the risk is that progress on inflation will stop, "or even reverse."

  • John Tobin, Dreyfus, BNY Mellon (Neutral on interest rate predictions):

    "What the market has been predicting and what the Fed has been delivering have been very different things... It wasn’t that long ago," that traders were pricing in a roughly 80% chance of a March rate cut. "That wasn’t our base case at all," he said. "We thought June was the right time, and still believe that today."

  • Jack McIntyre, Brandywine Global (Cautiously Optimistic on shorter-duration Treasurys):

    “Equities have done well... But one of these days, you are going to get an economic data point that’s going to question the soft-landing scenario.”