Slow and steady

Another September rate cut and another reason to consider liquidity products.

Common sense would say that when the Federal Reserve lowers its benchmark fed funds target range, as it did by a quarter percentage point two weeks ago, that interest rates and yields across the board would fall in concert. But finance doesn’t always operate the way it seems it should (who isn’t confused when first told that a bond’s price falls when its yield rises). 

It is true that yields of securities in the direct market, such as government auctions, overnight trading and floating-rate securities, adjust quickly to changes in the fed funds level, now in a target range of 4-4.25%. But that’s not the case for many financial products, such as mortgages and money market products. Mortgage rates key off the 10-year Treasury; money market portfolios use a “laddered strategy.”

In a falling-rate environment, “laddered” simply means money market portfolios hold securities of different maturities bought with the higher rates available before the Fed cut. This in turn typically causes yields of these portfolios to decline slower than those found in the direct market. That can make them attractive to investors, and accounts may see inflows. It was the case last autumn and true so far this year. As of Monday, the total industry has experienced inflows of around $55 billion since the Fed action, according to iMoneyNet. 

Caution flag

How fast the Fed takes to get to its terminal rate is far from certain. Its latest Summary of Economic Projections indicates decent consensus for two more 25 basis-point cuts this year, which would lower the target range to 3.50-3.75%. But if the government shutdown prevents the Bureau of Labor statistics from releasing the September jobs report, it is conceivable the Fed will hold rates steady at the October meeting. That would add further uncertainty to longer-term forecasts, specifically the predictions of the level of future rates. Called the dot plot, the projections of each member of the FOMC are indicated by black circles plotted on a graph. Well, the section of the graph representing 2026 looks like it was hit by buckshot. The wide dispersion likely reflects the reservation about President Trump’s pressure campaign. The legality of his removal of Lisa Cook from the board of governors is now in the hands of the Supreme Court. Whatever the outcome, the administration surely will continue its attempts to limit Fed independence, leading to the extra dose of uncertainty.

European milestone

I am happy to report that euro-denominated money market fund assets across firms have passed $1 trillion, a record according to Crane Data. That’s following the same pattern of growth amid falling rates. Despite the fact that the European Central Bank has taken its deposit rate to 2%, it would seem money funds are similarly becoming more attractive.

Commercial paper growth

Supply and demand is another important factor in the calculation of money market yields. That’s especially the case with commercial paper held by prime money funds. The amount of issuance continues to grow, largely resulting in higher yields and wider spreads above similar maturity Treasurys. And this market is becoming more diverse, with tech and manufacturing companies issuing short-term paper in addition to the bread-and-butter financial services sector. Diversification is a key element of money funds, so this is a notable development.

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