Why Is Cash Piling Up?

Money market funds (MMFs) are up by approximately $300 billion. Local government investment pools (LGIPs) are up almost $50 billion, 13% from a year ago. Ultra-short-term exchange-traded funds (ETFs) are up almost $63 billion, or 32% since last summer.

As we move through a period of extreme uncertainty in Washington D.C., it is no surprise that the markets are showing signs of anxiety. The political chaos, coupled with shifting fiscal policies, is causing volatility across many sectors. Even the slightest shift in sentiment seems to shake investor confidence and cause tremors in the market. Yet, amid all this uncertainty, one thing remains clear: investors are flocking to the safety of cash.

MMF Flows Continue to Grow

Positive flows continue. MMFs are up by approximately $300 billion, or 5%, since the start of December. LGIPs are up almost $50 billion, 13% from a year ago. Ultra-short-term ETFs are up almost $63 billion, or 32% since last summer, according to the Investment Company Institute (ICI). So, why is so much cash piling up?

Part of the answer lies in the extraordinary rally we have witnessed in the equity market over the past year and the continued strength in the credit markets (corporate debt). Investors appear to be favoring cash: safe, liquid assets, and taking a few “chips off the table.” I’m often asked, “When will the money start to flow out of cash?”

It seems unlikely that we will see that shift anytime soon – not until we witness a major sell-off and/or a recession will we likely see a significant drawdown in cash.

MMF Yields Increasing

While these money market inflows are undoubtedly significant, there has been talk that the broader liquidity environment is starting to tighten. The General Collateral Repo Financing Rate (GCR) and the Secured Overnight Financing Rate (SOFR), key indicators of money market rates, are beginning to move higher in yield vs. the Fed’s target rate range.

As the Fed continues its quantitative tightening program (QT), their reverse repo program (RRP) continues to wind down and we have seen a sharp decline in its usage from the peak of over $2 trillion in 2022 and 2023. Recently the balance dropped to a new low of $63 billion, although month-end funding pressures persist. December, January and February saw the RRP balance spike to $473 billion, $187 billion and $234 billion, respectively. This is not atypical as dealers tend to reduce their balance sheets at month-ends, but could these spikes also be implying that other funding pressures are emerging?

Realistically? Most likely not. But what is interesting is the spikes emerging in the GCR and SOFR markets, as these may be better indicators of potential stressors.

Change in Fed Balance Sheet Composition

We (Figure 1) appear to be a long way from the market of 2019. But will the gradual rise in these rates prompt the Fed to reconsider the pace of its QT program so as to avoid any surprises? Right now, the Fed’s balance sheet accounts for 23% of total US Treasury debt—down from a high of 37% in 2022, but up from around 20% prior to 2008, and, though not a particularly notable increase size-wise, it is the change in composition of its balance sheet that could have the Fed adjust QT.

Before the 2008 financial crisis, the Fed’s holdings were almost entirely T-Bills. Today, the holdings are mostly US Treasury notes and bonds and mortgage-backed securities (MBS). T-Bill holdings make up less than $200 billion of the assets.

There has been discussion around shifting the composition, so it better reflects the US Treasury’s overall maturity composition. T-Bills make up ~23% of the US Treasury’s issuance; thus, the Fed would potentially need to add $1.2 billion of T-bills to its portfolio to align with the US Treasury debt profile. The Fed has indicated that it will allow the MBS to roll off entirely. Perhaps the Fed would start to reinvest its MBS maturities into T-Bills? This change could have significant implications for short-term interest rates and could lead to a significant shift in demand and possibly a steepening of the of the yield curve.

This is where the role of the new US Treasury Secretary Scott Bessent becomes critical. The secretary must tread carefully in terms of Treasury issuance, as any shifts in the composition of government debt could have far-reaching effects on the broader bond market. Should the Fed also want to adjust the composition of its portfolio, it could trigger volatility in long-term rates that would ripple through the market.

As we position for the future, it is crucial to acknowledge that we are entering a period of heightened volatility and increased uncertainty. The current administration’s policy actions may not show their full effects on the economy for many months, and maybe up to a year. However, market participants are already feeling the pressure of this uncertainty. We must be vigilant in our approach, prepared for a wide range of potential outcomes.