Fed jumbo rate cut puts pressure on money market fund investors

By Suzanne McGee and Carolina Mandl

(Reuters) -Investment advisers are urging clients to dump hefty cash allocations now that the Federal Reserve has begun its much-anticipated interest-rate easing, a process they expect to limit the appeal of money-market funds in the coming months. 

Retail investors’ assets in money market funds have grown by $951 billion since 2022, when the Fed started its rate-hiking cycle to tame inflation, according to the Investment Company Institute, which represents investment funds. Their assets stood at $2.6 trillion on Sept. 18, roughly 80% higher than at the beginning of 2022. Total money market assets stood at $6.3 trillion.

"As investors are now more convinced that the Fed will reduce rates in line with its guidance, investors will likely grasp for yields that will not dwindle overnight," said Hannes Hofmann, head of family office group at Citi Private Bank, adding appetite for risk is likely to increase.

On Wednesday, the U.S. central bank cut the federal funds rate by a larger-than-usual 50 basis points to a range of 4.75% to 5%, which makes holding cash in deposit accounts and cash-like instruments less appealing. 

"You're going to have to shift everything ... further up in the amount of risk you're accepting," said Jason Britton, Charleston-based founder of Reflection Asset Management, who manages or oversees around $5 billion in assets. "Money-market assets will have to become fixed-income holdings; fixed income will move into preferred stocks or dividend-paying stocks."

Money-market funds - ultra low-risk mutual funds that invest in short-term Treasury securities and other cash proxies - are a way to gauge investor interest in the nearly risk-free returns they offer. When short-term interest rates climb, money-market returns rise with them, increasing their appeal to investors.

"Investors may need to look at something different, or longer-term, to lock in rates and not be as exposed to the Fed lowering interest rates," said Ross Mayfield, investment strategist at Baird Wealth.

Some investors could end up transferring funds from money market funds to equities, advisers say. Daniel Morris, Chief Market Strategist, BNP Paribas Asset Management, said the appeal of money market funds will wane. Morris said he sees better opportunity in equities and is slightly overweight equities versus fixed income.

Carol Schleif, chief investment officer of BMO Family Office, expects investors to keep some cash on the sidelines to wait for opportunities to buy stocks.

It could take a while for initial reactions to the Fed's decision on Wednesday to show up in money-market fund flows, as it has been tough to persuade retail investors to abandon their cash holdings, analysts note. Assets in money market funds tend to peak nine months after the first rate cut, BofA Securities said in a report.

"If people see a broader-based advance in stocks, they may move out of cash more quickly, as that would point to owning riskier assets as a good thing," said Christian Salomone, chief investment officer of Ballast Rock Private Wealth.

Investors "are stuck between a rock and a hard place," Britton said, faced with a choice between investing in riskier assets or earning a smaller return from cash-like products.

(Reporting by Suzanne McGee and Carolina Mandl; additional reporting by Davide Barbuscia; editing by Megan Davies, Rod Nickel and Nick Zieminski)