Record $7.6 Trillion in Money Market Funds Faces Pressure as Fed Poised to Cut Rates

Record Cash Holdings in Money Market Funds Amid Fed Rate Cut Outlook

Despite Americans not holding large amounts of physical cash, a staggering $7.6 trillion currently sits in money market funds, benefiting from the Federal Reserve’s recent interest rate hikes aimed at curbing inflation, according to data from Crane Data.

As the Fed prepares to reduce rates for the first time in a year—potentially by up to 50 basis points—attention is turning to the fate of this vast cash pool. Conventional Wall Street sentiment suggests such a “wall of cash” could fuel a stock market rally if it shifts into risk assets. However, this theory has been repeatedly challenged and remains speculative.

Fed’s Policy Shift and Market Implications

Recent labor market data indicate weakening conditions, increasing pressure on the Fed to implement rate cuts soon to prevent a rise in unemployment. Inflation figures, while not fully resolved, support expectations of at least a 25 basis point reduction at the upcoming Federal Open Market Committee (FOMC) meeting.

Shelly Antoniewicz, Chief Economist at the Investment Company Institute, emphasized that while the pace of cuts will depend on evolving data, lower rates will likely encourage gradual movement of money market fund assets into stocks and bonds as yields on cash equivalents decline.

Simultaneously, numerous mutual fund companies are preparing to offer ETF share classes pending regulatory approval from the Securities and Exchange Commission (SEC), aiming to capture investor flows amid these shifts.

Expert Skepticism on Large-Scale Cash Movement

Peter Crane, president of Crane Data, remains skeptical about significant outflows from money market funds despite the Fed’s actions. He notes that money market fund assets have historically only declined during periods of economic crisis when rates approached zero, such as after the dot-com bust and the 2008 financial crisis.

“Rates matter, but much less than commonly believed,” Crane stated. He highlighted that approximately 60% of money market fund holdings are institutional and corporate cash, which tend to remain stable and are unlikely to flow into equities.

Crane estimates that only about 10% of the $7.6 trillion might shift toward higher-risk investments, though precise data are unavailable. He also pointed out that with bank deposits offering substantially lower yields—around 0.5%—money market funds remain attractive even if rates fall moderately.

Yield Sensitivity and Investor Behavior

Currently, money market investors earn an average of 4.3% annually. Crane argues that even if Fed cuts reduce yields to around 3%, significant outflows are unlikely unless rates approach near-zero levels. Many investors hold relatively small balances in money market funds, making minor yield fluctuations less impactful on their behavior.

Additionally, the ongoing volatility in bond markets has increased risks associated with longer-duration fixed income, making money market funds a comparatively stable option for conservative investors.

Portfolio Strategies Amid Lower Rates

Given the anticipated Fed rate cuts, money market fund yields will not adjust immediately due to the weighted maturity of underlying securities. In the short term, assets in money market funds may even increase as higher-yielding securities mature.

Todd Sohn, technical and ETF strategist at Strategas Asset Management, suggests investors reassess their portfolios based on risk tolerance and tax considerations. For those seeking alternatives, laddered Treasury ETFs with durations of two to five years offer a balance between yield and volatility without credit risk.

Investors might also explore diversifying equity holdings, particularly in small- and mid-cap or international stocks, rather than increasing exposure to large-cap growth stocks that dominate the market.

Ultimately, the sizable money market fund balance reflects a complex interplay of investor preferences, regulatory changes, and macroeconomic factors. While some movement toward riskier assets is expected as rates decline, a wholesale migration is unlikely in the near term.