The Federal Reserve’s decision to cut interest rates by 0.5% on Wednesday could spark a shift in investment strategies, potentially pulling investors away from money market funds and into longer-duration bonds. This prediction comes from Timothy Ng, a fixed-income portfolio manager at Capital Group, who observes a historical trend of increased asset allocation to longer-duration bonds during periods of falling yields.
Data from the Investment Company Institute reveals a decline of $20.02 billion in total money market fund assets for the week ending September 18, reaching $6.30 trillion. This decrease includes $18.82 billion from government funds and $2.42 billion from prime funds. Ng anticipates this trend to continue as the Fed implements further rate cuts.
While Ng believes a portion of these funds may flow into both equities and bonds, he suggests the relative scale of this shift will depend on economic outlook, valuations, and market sentiment.
Recent years saw a surge in assets moving into money markets due to their attractive yields. However, Ng argues that this appeal is waning as the Fed plans further rate cuts. The reduced yields in money markets make them less appealing compared to the potential for capital appreciation offered by bonds, especially as yields fall.
The potential shift towards bonds is already reflected in the performance of exchange-traded funds (ETFs) that hold money market funds. ETFs like iShares Short Treasury Bond ETF (SHV), BlackRock Short Maturity Bond ETF (NEAR), SPDR Bloomberg Barclays 1-3 Month T-Bill ETF (BIL), and Invesco Ultra Short Duration ETF (GSY) have experienced slight gains in late-afternoon trading on Friday, hinting at this potential shift.
This scenario highlights the evolving dynamics within the investment landscape, where investors are constantly seeking the most favorable returns amidst fluctuating market conditions. As the Fed continues its course of rate cuts, it remains to be seen how these changes will ultimately impact the flow of funds between money markets and the bond market.
