Around the world, the much anticipated rate-cutting cycle is underway. In August, the Bank of England cut the base rate by 0.25 percentage points to 5%, while September brought a 50-basis point rate cut from the Federal Reserve. In October, meanwhile, the European Central Bank (ECB) cut interest rates for the third time this year.
“With inflation in retreat and growth resilient, the global economy has arrived at the fabled soft landing,” says Joseph Little, Global Chief Strategist at HSBC Asset Management. “This news, plus the Fed’s jumbo rate cut in September, catalyses a global rate-cutting cycle. This is good news for the global outlook; timely rate cuts mean that GDP and profits can broaden-out globally.”
He adds, “Our scenario is for a shallow rate-cutting cycle. We don’t see policy makers revisiting the 2010 era of ‘monetary policy on steroids’. Instead, we think policy is being recalibrated to 3-3.5% in the US and 2.75-3.25% for the UK, by the end of 2025.”
Nevertheless, uncertainty remains about the precise path central banks will take in the months ahead. Beccy Milchem, Global Head of Cash Distribution at BlackRock, notes that while central banks are likely to keep cutting rates, “there are still a number of variables that could impact exactly how many we see and the market pricing of how many cuts we will see continues to shift.”
Impact for money market funds
So, what does the falling interest rate environment mean for money market funds? Paul Mueller, Head of Global Liquidity EMEA portfolios at Invesco, points out that the onset of the current cutting cycle was largely anticipated, which has allowed money market funds (MMFs) to extend their weighted average maturities to help protect returns against declining yields.
But forecasting the depth and speed of these rate cuts remains challenging. “Central banks are currently operating in a data-dependent mode, facing uncertainties about future economic developments and whether inflation will stabilise at target levels or potentially re-accelerate,” Mueller explains.
“Much of this uncertainty is related to persistent ‘sticky’ services inflation and unpredictable wage growth, especially in labour markets that have become more difficult to forecast post-pandemic, compounded by demographic shifts and an increasing number of retirees.”
Mueller says that for MMF managers, the decision to include longer-term securities – which are aimed at safeguarding yields from further rate declines – requires accepting lower yields compared to those available through shorter-dated securities.
“This decision can be hedged by investing in floating rate instruments, which may perform better if rates do not decrease as swiftly as the market anticipates,” he says. “However, this creates a delicate balance: purchasing securities that may have already priced in excessive rate cuts could lead to sub-optimal yields, while delaying the extension of portfolio maturities risks missing the chance to lock in favourable yields if rates fall more quickly than expected.”
“On the face of it, lower policy rates pose a challenge for MMFs,” says Little. “Technical aspects, such as careful management of a duration ladder, can mitigate some of this. But the most important factor will be the shallow rate-cutting cycle, which will bolster MMF yields.”
As Mueller explains, the structure of a typical MMF portfolio allows it to generally outperform bank deposits when rates are cut, as bank deposits typically have much shorter maturities. “Investors are well aware of this dynamic, and during a rate-cutting cycle, we often observe increased inflows into MMFs,” he observes. “This influx can accelerate the rate at which MMF yields align with those of short-dated bank deposits.”
Meanwhile, BlackRock’s Milchem says that while rates – and therefore yields on MMFs – are coming down, “MMFs are likely to remain the best place for you to invest cash that you need daily access to. If we look back over historic markets, when interest rates are above 1.5%, MMFs typically see inflows.”
On another note, Milchem says investors should be aware that conversations about European MMF reform “will likely kick off again in 2025.” While reforms will take some time to agree and implement, she adds, “I would encourage investors to engage with the industry and bodies like IMMFA. The regulators want to hear from corporate treasurers on why these liquidity tools are critical for you.”
