Q2 2024 Cash Outlook
Check Your Blind Spots
With the Swiss National Bank cutting rates, cash markets were preoccupied with the exact trajectory of Fed policy and magnitude of rate cuts. But with inflation data coming in hotter than expected in April, and the distinct possibility of disruptions from recent geopolitical events, rate cuts now seem farther out than expected.
As we venture into Q2 2024, markets are mulling over the exact trajectory of interest rate adjustments by the US Federal Reserve (Fed) and other central banks. The Swiss National Bank had initiated rate cuts, and it was widely anticipated that other central banks would follow suit. So far in the US this year, discussions have ranged from no rate cuts in 2024 to the possibility of a first cut as early as March and significant cuts later on. However, in the light of the latest inflation data, and Fed Chair Jerome Powell's recent comments on inflation, it appears any possible rate cut will happen later this year, or perhaps not at all.
Looking ahead to 2024 and 2025, forward-looking data indicates a decelerating economy and a reduction in inflation to the Fed's targeted 2% range. What is unclear is the proximity to this range required for policy action and the extent of rate reductions necessary to meet objectives. Futures markets suggest that the Fed is unlikely to reduce the policy rate below 3.5% by the end of 2025, while the Dot Plot reflects a shifting consensus among Fed officials regarding the long-term neutral rate, which is no longer pegged at 2.5%. There are now eight Fed officials that feel the long-term neutral rate remains above 3%.
Though economic data certainly has had a lot of air time recently, we expect potential disruptions such as heightened geopolitical tensions in Eastern Europe or the Middle East, escalating conflicts between China and Taiwan, or financial market strains, including stresses in private debt refinancing, to impact Fed action. Such events may exert either dovish or hawkish pressures on monetary policy, influencing market dynamics.
Impending Reforms
In anticipation of potential rate adjustments, money market funds (MMFs) continue to push their durations, capitalizing on higher yields at the point of curve inversion. Despite these moves, we are already observing a slow decline in money market fund yields. Concurrently, the pending reforms for institutional prime money market funds pose significant considerations. Already it has been announced that more than $200 billion in assets will shift from institutional prime money market funds to government MMFs. The cascading effect of asset reallocation may prompt further adjustments among remaining funds, potentially further reducing the size of prime strategies. It is possible that we may see as much as 75% of the total AuM (~600 bn) shift away from this fund type.
We are closely monitoring the implications of the reform, particularly the anticipated shift toward one daily price by fund companies (currently there are as many as three pricings.) This adjustment aims to facilitate fee imposition and enhance shareholder benefits by providing ample time for processing shareholder activities. Additionally, an earlier fund closure could benefit shareholders by enabling strategic shifts in allocations.
Although the anticipated AuM shift may not significantly impact the broader market compared to the transition in 2016, the evolving landscape underscores the changing dynamics within money market funds. With reduced exposure to credit and potential adjustments in pricing mechanisms, fund companies are adapting to regulatory changes and aligning with the SEC’s objectives.
In summary, while the trajectory of interest rates remains a key focus, the evolving geopolitical and financial landscape, coupled with impending regulatory reforms, will shape market dynamics and short-term investment strategies in the coming months. We remain vigilant in navigating these evolving trends to ensure optimal portfolio positioning and risk management.