"U.S. Money Market Funds See First Outflow in 9 Weeks"
With the Federal Reserve's first rate cut in four years, global investment has entered a new era, and short-term investors have quickly adjusted their strategies to seek higher investment returns. One of the most direct reflections is that a large amount of funds that continuously flowed into U.S. money market funds during the Fed's continuous interest rate hike cycle have flowed out at a speed that is faster than the speed of sound, turning to stock funds and bond funds. Previously, due to these funds' pursuit of relatively high returns while also pursuing liquidity and safety, the scale of U.S. money market funds has repeatedly broken records, and it has now exceeded a scale of 6 trillion U.S. dollars.
According to EPFR data, money market funds invested in short-term high-quality securities, such as certificates of deposit and government debt with a term of one year or less, recorded a net outflow of funds for the first time in nine weeks in the past week ending this Wednesday, with a net outflow of $7.5 billion in a single week. Usually, investors will deposit funds in such money market funds when saving money for weddings, down payments for buying a house, or other short-term goals. From 2022 to last week before the Fed's rate cut, money market funds have always been the first choice for investors' short-term investments. Especially after the U.S. regional banks exploded, investors suddenly realized the problem of low bank deposit interest rates and high risks, and they surged into money market funds even more.
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But all this has been reversed with the Fed's rate cut. In fact, due to the continuous expectation of rate cuts, the returns on Treasury bills and time deposits have been below 5% for several months, which has gradually reduced the attractiveness of holding a large amount of cash. After the Fed cut interest rates by 50 basis points in one go last week, interest rates fell further. According to Citigroup's analysis of more than 20 regional banks, as of Monday's close, the median interest rate on time deposits fell by 0.25 percentage points compared to a week ago.
Moreover, investors are now betting that the Fed's subsequent rate cuts may exceed the "dot plot" implied this time. Tom Porcelli, Chief U.S. Economist at PGIM Fixed Income, told reporters from First Financial Daily that after the Fed started the rate cut cycle, the focus shifted to the market's expected neutral interest rate level and the time needed to reach this level. The Fed implied that it would cut interest rates by another 100 basis points in 2025. This move indicates that the previous large-scale rate cuts may allow for a more moderate pace of rate cuts later, allowing the federal funds rate to reach the expected level of 2.9% at the beginning of 2026.
While funds are flowing out of money funds, EPFR's data shows that stock funds tracking high dividend-paying stocks recorded the largest single-week inflow of funds in 24 weeks during the same period, and stock funds overall also recorded the largest single-week inflow of funds in two months, with $38.5 billion. In addition to the rate cut leading to a rise in risk appetite, large-scale stock buybacks also support more investors flowing into stock funds. Buybacks usually push up stock prices. Parag Thatte, an analyst at Deutsche Bank, said that as corporate profits increase, the total buyback amount of S&P 500 component companies may reach about $1.2 trillion next year, higher than the current level of $1 trillion per year. Therefore, "there is still room for funds to continue flowing into stock funds."
Not only stock funds, but bond funds also recorded a single-week inflow of $15.4 billion, bringing the annual inflow of funds close to $59 billion. Eric Beinstein, an analyst at J.P. Morgan, said: "The most logical explanation is that as the Fed finally cuts interest rates, some investors may be surprised by the first cut of 50 basis points, so they are turning to bond funds to lock in relatively high yields."
However, Sonal Desai, Chief Investment Officer of Fixed Income at Franklin Templeton, warned reporters from First Financial Daily that the market may be over-betting on the Fed's interest rate cut prospects. She also believes that "the most critical issue now is how far are we from the neutral federal funds rate?"
She analyzed that, using the actual federal funds rate as a simple measure, compared with historical levels, although the Fed's monetary policy is tight, it is not exceptionally tight. At the same time, even before this rate cut, financial conditions were not particularly tight, which can be easily determined from four indicators: U.S. stocks are close to historical highs, credit is still abundant, the spread between riskier high-yield bonds and U.S. Treasury bonds is very small, and the market's pricing of risky assets is completely inconsistent with the prospects of a contraction in economic activity and an increase in corporate bankruptcy rates. Moreover, Powell also warned for the first time at the press conference that we will not return to the ultra-low interest rate era of 2008-2022, and this time the neutral interest rate will obviously be higher than at that time.
"So, looking at the long-term average of nearly 2% before the global financial crisis in terms of real interest rates, I estimate that at the end of this easing cycle, the neutral interest rate should be between 3.75% and 4.0%. The Fed currently envisions reducing the policy rate to 3.4% by the end of next year and to about 3% at the end of the easing cycle. In comparison, the market expects the federal funds rate to drop to 2.75% by the end of next year. This divergence means that difficulties still lie ahead for the Fed." She said, "Past experience has shown that financial markets will continue to force the Fed to provide more easing policies than currently implied, especially when many investors still expect interest rates to eventually return to the extremely low levels after the global financial crisis. But the 'Fed put' also has a long record among investors. Therefore, we will see several rounds of the market overreacting to weak economic data with excessive excitement, but at the same time, it also increases the possibility of subsequent pessimism."