What signal? Institutions accelerate their entry, with nearly $90 billion flowing into money market funds in half a month

In the first half of August, nearly $90 billion flowed into U.S. money market funds as investors sought attractive yields to hedge against the expected rate cut by the Federal Reserve next month. According to data from fund flow tracking agency EPFR, from August 1st to August 15th, net inflows into money market funds holding cash and short-term assets, including government bonds, reached $88.2 billion, the highest in a half month since November last year. The data shows that the majority of the inflows are from institutional investors rather than retail investors. Institutional investors are large organizations that invest on behalf of others. Industry insiders say that the influx of funds reflects institutional investors' expectations of a rate cut, with the federal funds rate expected to drop from the current 5.25% to 5.5% next month. They added that the yields on U.S. Treasury securities typically decline before an expected rate cut and immediately further decline after the cut, but money market funds can offer higher rates because they have more diversified investment portfolios. Shelly Antoniewicz, Deputy Chief Economist at the Investment Company Institute (ICI), said, "We've seen growth in institutional investment really just in the last few weeks. The reason is pretty clear now that the Fed is more likely to cut rates in September." The funds flowing into money market funds so far this month highlight that these funds continue to compete with stocks and short-term bonds, becoming a safe haven for investors' cash. Money market funds saw significant gains in 2023 when the Fed raised rates to the highest level in 23 years to combat inflation. According to EPFR data, net inflows into money market funds last year reached a record $1.2 trillion, driven by strong demand from retail investors. Industry insiders say that institutional investors are now following suit. Deborah Cunningham, Chief Investment Officer for Global Liquidity Markets at Federated Hermes, said, "This often happens when rates start to fall. As bond yields decline in anticipation of further Fed rate cuts, investors are more willing to seek higher yields in money market funds." U.S. money market funds are allowed a maximum weighted average maturity of 60 days, meaning they can hold a variety of securities ranging from debt maturing in 3 or 6 months to shorter-term assets. According to Crane Data, the current average yield for U.S. money market funds is 5.1%. In comparison, the yield on one-month U.S. Treasury bills is slightly higher at 5.3%, while three-month Treasury bills yield 5.2%. So far, the overnight repurchase rate is 5.32%. However, Antoniewicz noted, "Direct securities such as overnight commercial paper, overnight certificates of deposit, etc., will see immediate changes in yield when or if the Fed starts cutting rates." He referred to the expected decline in yields of short-term assets traded directly in the market Although fund inflows continue this year, the speed of funds flowing into money market funds has slowed down as interest rates stabilize. Money fund managers and strategists indicate that there are signs that retail investors are shifting towards riskier asset classes, such as stocks. However, they point out that the August inflows are early signs of institutional funds flowing into this asset, as large companies needing working capital also seek cash returns. Cunningham said, "If you are a cash manager at a large institutional company with a large amount of cash, even just for a month, 10 basis points, 20 basis points can have a huge impact." Market participants also expect the Fed's rate cuts to be gradual rather than rapid and substantial, meaning that money fund yields will slowly decline over a longer period. Concerns about an upcoming economic recession were raised by weak U.S. job data released earlier this month, although stronger economic data have eased these concerns, the market still predicts a near one percentage point rate cut by the end of the year. However, Dreyfus Chief Investment Officer John Tobin pointed out, "In recent history, every rate cut has been to lower rates to zero due to a financial crisis. But that's not the case now, we're talking about rates at least ending at 3%." This means that even with a Fed rate cut, money market funds may continue to attract fund inflows. This time, "money funds are in a more favorable position," he said. Nevertheless, industry insiders acknowledge that the ability of money market funds to continue attracting funds depends on the sustainability of the U.S. economy, allowing the Fed to gradually lower borrowing costs. Cunningham describes yields above 3% as a "magical barrier" and states, "If money market fund yields start to fall below 3%, people will start to feel a bit uneasy and turn to other investments."