Q3 2024 Cash Outlook Poised to be Eventful

The Fed’s policy rate trajectory remains uncertain, with expectations of rate cuts in 2024 diminishing. But several other factors, such as the US presidential election, record cash levels, and regulatory changes in the money market fund industry, could be just as consequential for investors.

H2 2024 promises to be a period marked by uncertainty and evolving market dynamics. While the US presidential election looms large, its impact on capital markets is likely to be muted, barring a decisive shift in the balance of power. However, the potential for social disruption and the continuation of a divided government could hinder legislative action.

Key Areas of Focus

Several factors warrant close attention as we navigate the remainder of the year:

Federal Reserve Policy Rate: The Fed’s policy rate trajectory remains uncertain, with expectations for rate cuts in 2024 diminishing. The shift from as many as six 25 basis point cuts at the beginning of the year to now just one has been dramatic. The Fed Funds Futures market, at the time of this writing, is pricing Fed Funds at 4.87% in December 2026. We will closely monitor labor market conditions, as this will heavily influence the Fed’s decision-making.

A significant change to the labor market, such as the effect from major layoffs, could prompt earlier rate cuts. However, the current tightness in the labor market and lack of notable changes in labor supply suggest that this is unlikely in the near term.

Record Liquidity Levels: Abundant liquidity in the system, as evidenced by the record-high commercial bank deposits (over $17 trillion) and money market balances (over $6 trillion), indicates ready cash to deploy in the event of a market repricing or if an attractive business opportunity presents itself. This excess liquidity may cushion against potential market downturns.

Quantitative Tightening (QT) and the Fed’s Balance Sheet: The Fed’s reduction of its QT program (from $60 trillion to just $25 trillion US Treasuries per month) and the resulting stability in bank reserves suggest a cautious approach to balance sheet normalization. While the Fed aims to further reduce its balance sheet, the current economic conditions and ample liquidity indicate the Fed expects QT to run well into 2025. We will watch the Jackson Hole Symposium in August for the Fed’s view on the size of its balance sheet over the longer term.

Shrinking Reverse Repurchase Program: The continued decline of the Fed’s reverse repurchase program, which is expected to reach zero in the coming months, indicates a return to more normalized funding conditions. Recall this program was $2.4 trillion in size just 15 months ago. It has shrunk by $2 trillion over this period. This is a good trend and should not pose significant stress given the abundance of US Treasury Bills and the absence of Secured Overnight Financing Rate (SOFR) stress. Although primary dealer balances of US Treasuries have tripled since 2022, the Fed has additional support with their primary dealer financing facility to avoid the challenges experienced in September 2019.

Abundant T-Bill Supply: The substantial issuance of US Treasury Bills has been readily absorbed by money market funds and other cash investors, contributing to stable funding markets. The continued attractiveness of T-Bill rates may further support demand and provide a haven in these uncertain markets.

Commercial Paper Market Dynamics: Commercial paper yields, although slightly cheaper than months ago, remain relatively expensive given a potential recessionary environment and the relative value proposition compared to T-bills. Additionally, impending money market fund reforms, which could significantly impact institutional prime money market funds, may create upward pressure on yields.

Conclusion

The second half of 2024 will be far from quiet, with a confluence of events and evolving data shaping market dynamics. The presidential election, Federal Reserve policy decisions, record liquidity levels, and regulatory changes in the money market fund industry are just some of the factors that will contribute to an eventful and potentially volatile market environment.

While uncertainty abounds, ample liquidity, resilient funding markets, and attractive yields in certain segments may offer opportunities for investors who remain vigilant and adaptable. By closely monitoring these key areas and adjusting strategies accordingly, investors can navigate the challenges and capitalize on opportunities that lie ahead.