Fixed Income Strategy
Short-Term Market Research Note : MMF AUMs: Will you stay or will you go?
October 25, 2023
Short-Term Market Research Note : MMF AUMs: Will you stay or will you go?
Short-Term Market Research Note : MMF AUMs: Will you stay or will you go?
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Short-Term Market Research Note

MMF AUMs: Will you stay or will you go?

  • The relentless demand for MMFs has been one of the bigger highlights in the money markets this year. YTD, taxable MMF AUMs have increased by over $800bn and currently stand at nearly $5.9tn
  • What happens to this cash in 2024 not only has implications across the fixed income markets, but also more specifically in terms of demand for front-end assets, including RRP, and as a result, QT
  • Given the current outlook for interest rates, one common theme we have heard from market participants is the expected shift into longer duration fixed income, funded from drawdowns in cash. We think this is unlikely
  • A look at MMF flows going back to 1995, spanning over three easing cycles, shows that MMFs continue to see inflows even as the Fed begins to cut rates
  • Similarly, flows into MMFs tend to continue even as the curve begins to disinvert/steepen. It’s not until the curve more or less stabilizes that outflows begin to take place
  • Furthermore, the majority of MMF shareholders view MMFs as a cash management/liquidity tool rather than as an investment asset class as part of one’s overall investment portfolio, limiting the likelihood of cash pivoting into riskier asset classes
  • We also don’t think cash will pivot into bank deposits, even as bank deposit betas rise. Banks still do not want non-operational institutional deposits
  • Moreover, the yield spread between cash and bonds is expected to remain negative for the better part of next year, suggesting little incentive to immediately extend out the curve

The relentless demand for MMFs has been one of the bigger highlights in the money market this year. YTD, taxable MMF AUMs have increased by over $800bn and currently stand at nearly $5.9tn (Figure 1). Typical seasonal inflows in 4Q could easily push those balances beyond $6tn by the end of this year. The regional banking crisis in March, alongside an inverted yield curve that has cash yielding above 5%, and negative returns in riskier asset classes, have all contributed to the impressive rise in MMF balances this year.

Figure 1: YTD, taxable MMF AUMs have increased by over $800bn and currently stand at nearly $5.9tn

Total AUMs of taxable MMFs ($bn)

Source : Crane Data, iMoneyNet, J.P. Morgan

In 2024, what will happen to this cash? The answer not only has implications across the fixed income markets, but also more specifically in terms of demand for front-end assets, including RRP, and as a result, QT. Given the current outlook for interest rates, one common theme we have heard from market participants is the expected shift into longer duration fixed income, funded from drawdowns in cash. In essence, do we anticipate another Great Rotation, similar to the one in 2009-2012, when over $1tn rotated out of MMFs and into bond funds, reducing MMF balances by about a third?

We think a shift from cash to fixed income is unlikely. A look at MMF flows going back to 1995, spanning over three easing cycles, shows that MMFs continue to see inflows even as the Fed begins to cut rates (Figure 2). Notably, this dynamic is applicable to both institutional and retail flows. Intuitively, this makes sense, as MMF yields tend to lag yields of direct cash alternatives such as T-bills when the Fed begins to cut rates, thus attracting flows from other liquidity alternatives (Figure 3). We also took a look at MMF flows versus changes in the curve shape. As Figure 4 shows, flows into MMFs tend to continue even as the curve begins to disinvert/steepen; it’s not until the curve more or less stabilizes that outflows begin to take place.

Figure 2: A look at MMF flows going back to 1995, spanning over three easing cycles, shows that MMFs continue to see inflows even as the Fed begins to cut rates

Quarterly MMF flows (LHS, $bn) vs. fed funds target upper bound (RHS, %)

Source : Crane Data, iMoneyNet, J.P. Morgan

Figure 3: MMF yields tend to lag yields of direct cash alternatives such as T-bills when the Fed begins to cut rates, thus attracting flows from other liquidity alternatives

Government MMF net yield spread to 1m and 3m T-bills (LHS, bp) vs. fed funds target upper bound (RHS, %)

Source : Crane Data, iMoneyNet, J.P. Morgan

Figure 4: Flows into MMFs tend to continue even as the curve begins to disinvert/steepen; it’s not until the curve more or less stabilizes that outflows begin to take place

Quarterly MMF flows (LHS, $bn) vs. Treasury curve (3m2y, 3m5y, and 3m10y) (RHS, bp)

Source : Crane Data, iMoneyNet, J.P. Morgan

Additionally, when we think about MMF flows, we take into consideration whether the cash residing in MMFs is used for cash management/liquidity purposes or whether it is used as an investment asset class as part of one’s overall investment portfolio. For the most part, market participants use MMFs for the former reason, seeing MMFs as low-cost, efficient, transparent cash management vehicles that offer market-based rates of return. This is particularly true of institutional MMF shareholders such as corporations and state and local governments, who typically value return of capital versus return on capital. Yield is secondary. The fact that MMF AUMs reached nearly $5tn in 2021, when rates were at zero, equities rallied, and the rates curve was solidly in positive territory, is supportive of this view. The recent regional banking crisis provides another example, after which institutional MMF balances grew by ~$375bn over the months of March, April, and May. Given that these inflows were driven by uninsured depositors turning to other cash alternatives in order to diversify their liquidity needs, we believe this money is here to stay and unlikely to pivot into riskier asset classes. Nor do we think the cash will pivot into bank deposits, even as banks raise their deposit betas. Banks still do not want non-operational institutional deposits on their balance sheets. Institutional MMF AUMs currently make up about 65%, or $3.8tn, of total taxable MMF AUMs. Retail MMFs make up the remainder, and while they are more sensitive to cash reallocations, the outlook for interest rates does not suggest a large shift into fixed income next year. Indeed, even when the Fed begins to cut rates, the yield spread between cash and bonds is expected to remain negative for the better part of next year, suggesting little incentive to immediately extend out the curve (Figure 5). Furthermore, allocations to MMFs as a percentage of the overall mutual fund industry does not seem outsized as we saw in 2009-2012, when MMF allocations made up 30-40% of mutual fund assets, versus 15% today, which suggests the likelihood of mean reversion is low (see Traditional Asset Management Perspectives: Cash vs. Fixed Income, K. Worthington, 10/3/23).

Figure 5: The yield spread between cash and bonds is expected to remain negative for the better part of next year, suggesting little incentive to immediately extend out the curve

1m-30y Treasury curve, current vs. 6-12m forward rates (%)

Source : Bloomberg Finance L.P., J.P. Morgan

Overall, with the expectation that the Fed is going to stay higher for longer and with MMFs yielding above 5% for same day liquidity, MMFs remain compelling both as a liquidity product and as an investment asset class. We do not anticipate the relative value of MMFs versus deposits, short-term bond funds, equities, etc. to change dramatically in the near future (Figure 6). While there might be some rotation out the curve, we suspect the magnitude will not be as meaningful as the inflows we saw this year. All told, elevated MMF AUMs appear here to stay.

Figure 6: We do not anticipate the relative value of MMFs versus deposits, short-term bond funds, equities, etc. to change dramatically in the near future

Net yields paid on ultrashort credit funds, high yield online deposits, prime MMFs, and S&P 500 dividend yield (%)

Source : Morningstar, SNL, Crane Data, Bloomberg Finance L.P., J.P. Morgan

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