Few would disagree that rate cuts are on the horizon for major money market fund (MMF) currencies. However, expectations regarding the scale and timings of these cuts continue to evolve.
“Many central banks have adopted a data-dependent stance, looking at inflation and employment figures, amongst other data releases, in their evaluation of monetary policy,” says Beccy Milchem, Global Head of Cash Distribution and Head of International Cash Management Business at BlackRock. “But economies continue to surprise to the upside, which is resulting in the market repricing and interest rate expectations constantly evolving.”
Rate expectations
Following a series of interest rate hikes in the last couple of years, the beginning of 2024 came with the expectation of rate cuts. Focusing on the interest rate outlook in the UK, Paul Mueller, Head of Global Liquidity, EMEA Portfolios, at Invesco points out that at the start of the year, markets were expecting a first interest rate cut by June 2024. “This was driven partly by UK headline inflation levels falling nicely from 10.5% at the end of 2022 to 4% by the start of 2024, but also signs that the labour market was beginning to soften, via lower vacancies.”
He adds that at the start of the year there were still concerns UK wage growth was too high to be consistent with a 2% inflation target, “but this was somewhat offset by the latest UK GDP numbers that confirmed the UK had a “technical” recession in the second half of 2023.”
More recently, says Mueller, global inflation, especially in the US, has proved much stickier. Alongside continued strong US growth, this “has seen markets push back on the timing of rate cuts, not just in the US but also in the UK, from as early as June 2024, to now closer to August or September 2024.”
Looking beyond the expected first rate cut, Mueller says that markets currently price the BoE rate to be at 4.75% by Q2 2025. “However, the increased economic uncertainty right now means that cuts could still come more quickly or even be delayed beyond September so the BoE will remain very data dependent.”
He adds that this means MMFs should remain a safe harbour for cash, “while still achieving yields at least, if not better, than bank deposits in a more diversified portfolio. If/when rates are cut, MMFs tend to outperform bank deposits as they will generally hold some longer-term securities that will prevent their yields falling as fast as deposit rates.”
Diverging approaches
Hugo Parry-Wingfield, EMEA Head of Liquidity Investment Specialists at HSBC Asset Management, likewise notes that the UK market “is currently pricing up to two cuts this year starting August/September.” But while rate cuts continue to be expected, he points out the situation for G3 currencies is “diverging”.
In the US, he says that a relatively strong economy coupled with stubborn inflation suggests the Fed may delay cuts, with markets pricing up to two cuts in 2024 starting in September – “much less than earlier forecasts.”
In Europe, meanwhile, Eurozone inflation is falling but the economy has stalled. As Parry-Wingfield observes, “The ECB has implied cuts are coming, and the market is currently pricing three this year starting in June/July.”
Navigating market conditions
For MMFs, current market conditions are something of a moving target. Milchem comments that with an uncertain path for interest rates and geopolitical events weighing on risk sentiment, “adding duration to a liquidity portfolio needs to be approached with caution.”
In EUR, Parry-Wingfield says HSBC Asset Management has been maintaining a relatively short weighted average maturity (WAM), “as we think the market has been too aggressive pricing cuts to date; for GBP we believe the market is more fairly priced, so WAM is slightly longer.”
In both cases, Parry-Wingfield says the asset manager uses floating rate investments that have offered attractive credit spreads for longer maturities. “We will use fixed rate securities and extend WAM if we see value,” he adds. “For USD, we have been maintaining a longer WAM but also layering floating rate instruments at attractive spreads to protect against ‘higher for longer’.”
But as Parry-Wingfield points out, the interest rate view is not the only consideration to affect the positioning of MMFs. Other significant factors include current market dynamics, such as the reduction of system liquidity via ‘quantitative tightening’, as well as the need to ensure that portfolios always have sufficient liquidity. At the same time, the current global geopolitical environment cannot be ignored.
As Parry-Wingfield concludes, “Taken all together, in other words, the interest rate view is not the only factor that will drive how a fund is positioned.”
