UBS: Where will $6tn in money markets flow as the Fed cuts?

UBS strategists anticipate a significant movement of the $6 trillion currently held in money markets as the Federal Reserve begins cutting rates. The first cut is expected in September, followed by another in December and six additional cuts in 2025, which will likely lead to a shift in short-dated fixed-income allocations.

Money market fund (MMF) assets have seen substantial growth, reaching over $6.1 trillion by Q2 2024 from $5.4 trillion in Q2 2023 and $3.2 trillion in Q2 2019, marking a compound annual growth rate (CAGR) of approximately 14%.

The household share of these balances has grown faster than corporate shares, with a 16% CAGR versus 12%, resulting in households holding $4.0 trillion or 66% of all MMF balances, up from 59% in 2019.

UBS foresees substantial inflows into corporate bonds as investors shift existing allocations further out on the maturity curve and some cash moves from the sidelines into mutual funds and ETFs. Higher total returns are projected in investment grade (IG) 7-10 year, IG 10 year+, and High Yield (HY) segments, with forecasts at 7.1%, 7.7%, and 7.4% respectively over the next 11 months, compared to MMFs at 4.8%.

Higher-income households, particularly those in the 80th to 99th income percentiles, are expected to be key players in this shift. Their MMF assets have risen significantly, reaching $2.3 trillion from $1.0 trillion since 2019, representing over half of outstanding consumer balances.

“Relative to their financial assets this income cohort’s MMF assets are above average at 3.9% (of a total asset base of $57tn) vs. an average of 3.1% since 1989. But deposits are 10.6% vs. an average of 11.5%, so some of the higher MMF balances may be the mix of cash shifting,” UBS noted.

Historically, MMF asset growth in this cohort is positively correlated with the Fed Funds rate, with a lag of about one quarter. During periods of declining Fed Funds, MMF asset growth has typically turned negative, though this trend may vary depending on broader economic conditions.

“For comparison, across corporations the $2.0tn in MMF assets remains quite concentrated: by sector tech holds about one-third of all cash, and the top 5 firms hold about one-quarter of all cash,” strategists wrote.

“While guidance on future investment plans is spotty, strategists see future M&A, capital spending and returning cash to shareholders as competing alternatives that will limit any large investment reallocations from MMFs into US asset markets,” they continued.

Foreign demand is also expected to play a crucial role. During previous Fed rate-cutting cycles excluding recessions (1998, 2007, 2019), aggregate inflows into corporates have been near averages.

Mutual funds and ETFs accounted for 27% of total demand, while foreign investors contributed 34%. UBS forecasts a similar trend in the upcoming cycle, with inflows into fixed-rate corporates likely to increase, bolstered by declining FX hedging costs.