As uncertainty surrounding the Federal Reserve's policy path and the outlook for short-term interest rates intensifies, US money market funds are taking further steps to reduce interest rate risk by accelerating their allocation to ultra-short-term assets. This move aims to preserve flexibility for reinvesting at potentially higher yield levels in the future. Data from Crane Data indicates that the weighted average maturity of holdings in money market funds has decreased from 45 days in mid-May to 40 days currently.
Fund managers are directing more capital into overnight repurchase agreements, short-term securities, and floating-rate US Treasury and agency bonds. Concurrently, their allocation to US Treasury bills has seen a decline, even as the US Treasury Department continues to increase the issuance of short-term government debt.
Recent developments, including rising international oil prices and hawkish remarks from Federal Reserve officials like Governor Waller, had fueled market bets for a potential rate hike as early as this month. However, the release of two moderate inflation reports last week has again muddied the policy outlook, prompting investors to recalibrate their interest rate expectations.
Against this backdrop, US money market funds, which collectively manage over $8 trillion in assets, show a preference for assets that mature within weeks, can be rolled over, or have rates that reset quickly. This strategy enables them to promptly reallocate funds to higher-yielding products should interest rates rise again.
Deborah Cunningham, Chief Investment Officer for Global Liquidity Markets at Federated Hermes, noted, "Investors want to keep ample 'dry powder' to seize better investment opportunities ahead, which leads them to appropriately shorten the weighted average maturity of their portfolios."
Market participants point out that fund managers are keen to avoid a repeat of early 2022. During that period, some institutions held longer-duration assets just before the Federal Reserve initiated one of its most rapid rate-hiking cycles in decades, leaving portfolios exposed to significant interest rate risk. This experience has made managers more cautious while the current policy direction remains unclear.
Geoff Gibbs, Managing Director at DWS Group, stated at a Crane money market funds seminar last month that the firm has maintained roughly half of its portfolio in repurchase agreements this year and expects to continue this strategy, particularly as markets begin to price in renewed rate hike expectations.
Data shows that in June, US money market funds increased their allocations to repurchase agreements by approximately $36 billion, bringing the total to around $1.89 trillion.
Simultaneously, funds have also been steadily increasing their holdings of floating-rate notes. Strategists Angelo Manolatos and Francis Brown from Wells Fargo observed that holdings of US Treasury Floating Rate Notes reached a record $523 billion in June. This reflects fund managers' desire to lock in the relatively high yields of three-month Treasury bills without extending their portfolio duration.
Furthermore, Federal Home Loan Bank financing data reveals that FHLB bond balances have increased by about $180 billion this year, with roughly $140 billion of that coming from floating-rate note issuance. Over the same period, money market funds' overall holdings of agency debt have grown by approximately $195 billion.
In contrast, despite the US government's ongoing expansion of short-term Treasury issuance, money market funds' holdings of US Treasury bills decreased by nearly $105 billion last month.
Cunningham anticipates that the average duration of money market fund portfolios will continue to shorten as the Federal Reserve remains focused on bringing inflation back down to its target level.
Manolatos added that with the possibility of a September rate hike still on the table and several Fed officials continuing to signal a hawkish stance, money market funds are expected to keep gradually shortening their holding periods. "For fund managers, unless there is a compelling reason otherwise, the preference is to deploy new cash into repurchase agreements or floating-rate notes rather than taking on additional duration risk," he concluded.
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