Fear, greed, and money market funds

Every crisis has its losers. But what of the winners?

Since SVB blew up – followed by two regional US banks and the rescue deal for Credit Suisse –  the safety of bank deposits has come under intense scrutiny. 

Investor anxiety has benefitted the largest money market funds, with the likes of Goldman Sachs, JPMorgan Chase and Fidelity seeing huge inflows (more than $286bn in March, making it the biggest month of inflows since the depths of the Covid-19 crisis).

Fear and greed

Yes, there's an ongoing flight to quality, with depositors keen to switch out of bank risk into low-risk assets that are easy to buy and sell, including short-dated US government debt. Ultimately money market funds are diversified portfolios of liquid assets. Bank deposits are unsecured liabilities on banks’ balance sheets.

But this is also a question of yield. The Fed's fight against inflation has led rates to 15-year highs, making money market funds attractive once again.

Some bank deposit rates may exceed money market fund yields in the early stages of a rate hiking cycle. However, it is important to keep in mind that bank deposit rates have historically lagged rate hikes and money market fund yields once a hiking cycle is underway. 

The big question

Following on from last week’s blog, when we explored what might emerge from the Credit Suisse chaos, we’re essentially asking where is the safest place to park cash right now?

Physical banknotes stuffed under a mattress have zero counterparty risk, but they have plenty of other risks, including theft and termites. Until a few weeks ago, people would have assumed that a bank deposit would actually be the safest place, but now it’s clear that for any amount above the deposit insurance limit, cash in the bank is actually at risk.

A new perspective

Crucially, it might turn out that money-market funds are safer than bank deposits, as your cash is fully invested in short term high quality government securities – it’s not lent out and fractionalised in a way that bank deposits are. 

The value of your cash might fluctuate a tiny amount. In 2008 there was a lot of consternation when a few money market funds “broke the buck” (ie, their NAV dropped below $1), which is never supposed to happen.

But in a world where a bank deposit might end up becoming an unsecured creditor and have a recovery value of 50 cents on the dollar, being invested in a fund where the NAV has a tiny risk of dropping to 0.99 but is otherwise either always worth 1 or even pays interest, seems pretty good. 

Banks have been pretty reluctant to pass on rate rises to their customers, and now that they aren’t considered as safe anymore, money-market funds (especially those that invest exclusively in government bonds) seem like a no brainer.

Implications for bond markets

All this should have an impact on the currently incredibly inverted yield curve. 

2s10s in Treasuries were inverted by 107 bps during the “SVB weekend”! That has reverted a bit, but we’re still about 50bps inverted, which is roughly where things were for most of the past 8 months. Obviously a lot depends on if the Fed keeps raising rates, but consensus seems to be that we’re near the end of the cycle.

The world is shifting beneath our feet, precipitating a wholesale process of adaptation. The repricing of risk is real. As central banks continue to raise rates, investors must look afresh at key considerations like risk, yield, liquidity and price stability.

Tolstoy famously observed that, “All happy families resemble one another, but each unhappy family is unhappy in its own way.” The same applies to financial markets. Every crisis is different – defined by the way in which investors respond to its challenges.