Is Money Market Mania a Tailwind or Headwind?

Before the digital age of this generation, money flows were sticky and slow to move relative to the light speed capabilities today. Institutional money as well as low-income consumers can now instantly move money around. For companies, especially less sophisticated banks, this is a risk if they lack digital oversight and capital controls to avoid a panic run on their money. The March and May regional banking panic of just 4 banks rivaled the entire 2008 – 2010 failure of over 400 banks during the Great Financial Crisis, in nominal asset destruction. This time the Federal Reserve System had the 2008 toolkit in place to ring fence the panic, printing money and forcing sweet-heart asset and liability transfers among the mega cap banks. Most investors already have amnesia of the massive banking failures earlier this year, but they have shifted their loyalties more toward quasi-Government backed mega cap banks (JP Morgan, Citi, Wells, BofA…) that offer better yields and security.

The movement of money at light speed today can be a risk for lenders, but also encourages individuals to react rapidly to economic panics and periods of interest rate volatility. As seen in the chart below, in 2008 investors moved from stocks to money market funds to avoid volatility risk. It was a time when preservation of capital was more important than profits. When the panic subsided in 2009 and 2010 and the Fed had artificially suppressed bond yields and flooded banks with free cash.  No yield money market funds were drained and became a tailwind for investors as they used their cash to buy “risk on” stock. During the next panic, when Covid struck in March of 2020, investors briefly transferred their risky stock accounts back into money market cash for safety. This time the Fed was ready with their shock and awe campaign, moving swiftly to force bond yields to zero, aided by massive Government handouts that flooded the stock market with new investments. Free money and zero % Government bond yields served as a tailwind for equities until 2022. There was no reason to buy CD’s or money market funds until 2022, when the Fed took away the free money punch bowl and pulled bond yields higher along with the inflation that Fed Chair Powell and Biden created. With an economy at full employment today and yields still rising to multi decade highs, excess cash continues to flow into stocks and low risk money market funds yielding 5.5%. Money market funds are now holding approximately $6 trillion. The giant sucking sound of cash moving into short term treasuries, CD’s and money market funds has not hurt stocks as excess liquidity, irrational Government stimulus and full employment sustain the move into Bonds along with a narrow Bull market in equities. 

In a recent interview on the Financial Sense Network (FinancialSense.com) we were asked if the rising tsunami of cash into money market funds was a headwind for stocks. I said it had not been a headwind and going forward it could eventually be a tailwind. We would add a major caveat that the transition risk for equities and the economy will be when inflation and consumer spending slow enough to send yields into a downtrend, as in late 2007. Stocks will struggle during this phase that is expected as in 2024. However, the downside risk should be more limited in 2024 than the fallout in 2008 as the Biden administration has strategically staged trillions of incremental stimulus measures for his reelection cycle. All Presidents attempt such an endeavor, but Biden’s timing at the end of Covid was prescient. Additionally, the Fed demonstrated during the mini-Banking panic this Spring that they will act instantly to flood the system with funds as needed to curtail rising unemployment and extreme financial fear. For now, rates are rising this past year over fears that the economy is too strong in order for the Fed to stop raising rates in its quest for 2% inflation. Two-year treasury yields today exceed 5%, One-year yields are testing 5.5% and One-month T-Bills are now 6%. As we have discussed over the summer, with elevated mega cap stock valuations peaking and risk-free yields above 5%, it’s a suitable time to maintain some diversification with fixed income as we approach the riskier peak in the interest rate hiking cycle.

 

With the Fed’s PCE inflation measure falling from 5.5% to 3.9% over the past 12 months, we are of course closer to peak rate hikes, but still less than halfway to their 2% target. As the previous chart shows, free market investors continue to push yields higher even as demand for Money Market saving accounts grows. Typically, investors anticipate a Fed easing cycle of rate cuts months in advance with widening credit spreads and T-Bill rates falling beneath the fed Funds rate. Once that phase begins, stocks will correct further over uncertainty of economic slowing and rising unemployment. 

If interest rates have the downturn that we expect in 2024, small cap stocks and international equities should outperform the current leadership of the overweight mega cap generals among the Trillion-dollar club. For now the broader market needs a few months of falling rates to set their table for a new Bull market next year. The narrow equity Bull market led by large cap companies is in for a choppier period ahead, but can continue higher by year end after our forecasted seasonal liquidation period ends in October. Technically, as long as the cash SP 500 Index (SPX) can hold 4320’s support, above its 200-day moving average (dma), prices can rally with increasing momentum later in Q4. Any test of the 200 dma and the risk will rise that institutions are prepping for 6% Treasury rates and shifting more from stocks to bonds until the SPX falls below 4000. 

As for the record $6 trillion of cash – and growing – in money market accounts: it’s a neutral factor for equities while yields are rising during a fully employed economy; it will become a negative when yields start falling (2024); and then a significant longer term positive for stocks after short term Treasury yields fall back under 4% and the economic slack generates new waves of Federal liquidity.

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