The appeal of earning 4% or 5% on time deposits and federal money market funds lies in the perception of risk-free money. Despite any skepticism about the U.S. credit pledge, T-bills and FDIC guarantees are currently considered as safe as cash, with the added assurance that FDIC insurance extends to all deposits above the official limit.
Earning such yields with no apparent risk is an attractive proposition, especially given the current rate of inflation according to the Bureau of Labor Statistics.
However, the downside of earning 4% or 5% on risk-free cash and cash equivalents is that it falls short of the potential 40% or 50% gains that could be achieved by taking on more risk, such as investing in small-cap index funds. Such funds, which charge only a few basis points, faithfully track a cap-weighted benchmark dominated by a powerful oligopoly.
In 2022, high-yielding cash is favored as policy decisions push up the yield on riskless dollars, causing the oligopoly’s stocks to be devalued. In 2023, however, mega-cap multiples shifted away from high yields, resulting in significant underperformance for cash.
Interestingly, despite the underperformance in 2023, there was a notable influx of money into money market funds (MMFs), and the year marked an unprecedented surge in MMF assets under management, which increased by $1.1 trillion and continue to grow.
The presence of a substantial amount of dry powder is noteworthy, even though the most recent weekly reporting period saw the first outflow in two months. This cash accumulation trend could continue for some time, barring a scenario in which too many investors succumb to FOMO (fear of missing out). It’s important to keep this possibility in mind, because while cash in money market funds (MMFs) has essentially been on the sidelines, it has served two important purposes. First, it has supported consumption by generating interest income that amounts to about $20 billion a month in free cash for the wealthy.
Second, it has played a role in preventing a liquidity squeeze through the MMF-RRP-T-bill nexus. In this mechanism, money funds move out of the Federal Reserve’s parking garage and into Treasury bills, helping to mitigate the drain on reserves as the Treasury rebuilds its cash balance.
From the time the debt ceiling deal was struck in early June through the end of November, the reverse repurchase agreement (RRP) saw a significant outflow of $1.3 trillion.
The situation presents an interesting conundrum for the first half of 2024. On the one hand, the $6 trillion in assets under management (AUM) in money funds could potentially serve as a source of funding for a surge in risk assets. On the other hand, widespread redemptions from money market funds (MMFs) could remove an important systemic backstop at a sensitive time. The balance between these factors adds complexity to the financial landscape going forward.
