(Bloomberg) — While the global financial system waits for the Federal Reserve to begin lifting interest rates, funds across the money-market industry are positioning their cash to take advantage of the higher yields to come.
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For some funds that means shortening exposure to interest-rate shifts in their portfolios. As of Feb. 14, more than 100 money markets funds had a weighted average maturity, or WAM, of 10 days or less, including some Federated Hermes funds at 1 day, according to money-market information provider Crane data. That’s up from 85 funds on Jan. 24 and 77 at the end of December.
Money-market funds are supposed to be boring places to park cash and earn a little interest. Close to $5 trillion is split between relatively risk-free government-focused funds and so-called prime funds, which invest in both corporate and government notes. They’re central to the way financial markets operate, as a source of funding for companies and a safe space for investors.
Money-market funds have been hit hard by the central bank’s easy monetary policy. When the Fed slashed its main interest-rate target to 0% to 0.25% in March 2020, the industry was forced to waive fees to preserve what little yield funds were earning on their investments, and some even shuttered after struggling to cover operating costs in the low-rate environment. Now with policy makers on the precipice of an aggressive series of rate increases, fund managers don’t want to miss the window of higher rates.
“There’s a lot of uncertainty about the Fed hiking path and as long as there is a very real risk they hike 50 basis points it makes sense that money funds remain short,” said Mark Cabana, head of U.S. interest-rates strategy at Bank of America Corp. “If you’re a money fund, you don’t want to take that risk.”
Odds of a 50 basis-point rate boost started rising after the Jan. 25-26 Federal Open Market Committee meeting when Chairman Jerome Powell opened the door to more frequent and potentially larger hikes than anticipated to curb inflation. Overnight swaps pricing for rate hikes are currently pricing around 36 basis points, or 1.4 hikes, into the March meeting.
The market is pricing about 93 basis points in the next three meetings.
Looking out further, traders on Feb. 11 had expected the Fed funds rate after next December’s meeting would be 1.84%, according to overnight index swaps. As of Wednesday, that projection has dropped to 1.55%. The minutes from the January gathering released Wednesday showed officials concluded that inflation was running too high, warranting a hike in the benchmark interest rate soon. Minutes also showed Fed participants observed that the high level of the central bank’s securities holdings would warrant a “significant reduction” in the size of the balance sheet.
For money funds, a 50 basis-point increase means a quicker return to more normal conditions, such as the reimposition of fees and the ability to offer more yield than bank deposits, which tend to lag money markets when it comes to adjusting to Fed rate increases.
Reverse Repo
Should the Fed’s trajectory remain uncertain, or policy makers opt for the more conventional path of quarter-point hikes, money funds may continue to lean on the central bank’s overnight reverse repurchase agreement facility, even pushing balances above $2 trillion, according to Cabana. Demand for the so-called RRP is around $1.64 trillion, off the all-time high of $1.91 trillion reached on Dec. 31.
“Until the dynamic changes, the reverse repo facility is going to remain elevated,” he said.
(Updates market pricing of Fed rate hikes, adds FOMC minutes.)
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