Sweet spot

Cash should still reign The liquidity industry’s gain from stock and bond investor pain should continue in 2023. In particular, with yields rising with each Federal Reserve hike, money markets should retain their status as an in-demand asset class. Money funds in particular should hit a sweet spot even when hikes cease because they are able to invest further out the yield curve to seek higher yields. The Fed’s quantitative tightening should finally have a meaningful effect on the front end of the curve as the amount of Treasuries moving from its balance sheet to the marketplace becomes big enough to provide relief to government money funds. We also think the municipal market will stabilize at attractive levels as early as this quarter. Lastly, the prime space should continue its success borne of large spreads over Treasuries, led by retail prime inflows.

Inflation and the Fed Neither the elephant nor the 800-pound gorilla, respectively, will exit the room in 2023. Market enthusiasm over inflation’s recent softening and expectations for a policy pivot suggest investors do not respect the Fed’s resolve. They would be wise not to focus on the reduced magnitude of upcoming hikes (we expect 50 and 25 basis-point increases, respectively, in the next two meetings) but on the length of a pause that likely will follow. This is where the Fed will have wiggle room to bully the economy as it sees fit. The longer it maintains an elevated terminal rate—possibly a touch over 5%—the more pressure it will put on the economy. While we think inflation has peaked, we are positioning for a hawkish Fed in 2023.

Money fund regulation delayed? Once on the fast track, new money fund reform appears to have been passed by other pressing business. The implosion of FTX has put cryptocurrency high on the SEC’s target list, and its proposal for swing pricing in non-money-market funds is facing major pushback. We are hopeful that the continued delay also is because the SEC is taking the liquidity industry concerns about potential money fund changes into account. The most troubling of these are mandating retail and government money funds to float NAVs in a negative-rate environment and for institutional prime and municipal products to adopt swing pricing in times of net redemptions. Whatever regulations are passed likely won't be implemented until 2024.