After years of ultra-low interest rates, the Federal Reserve’s aggressive rate-hiking policy has been nirvana for money market investors. Many have found that spreading their clients’ cash across multiple liquidity vehicles, including money market funds, and time horizons, such as spreading non-operating cash across higher-yielding products, is a sound strategy. But as inflation continues to fall and the extraordinarily strong labor market warms, will this happy environment be over as we move toward 2024?
We think not. Throughout the tightening cycle, US monetary policymakers have made it clear that they will not repeat the mistakes of the past, when they assumed inflation had recovered and then reversed course. When the US Department of Labor released lower-than-expected consumer price index (CPI) data for October, markets responded with cheery gains. But the Fed likely viewed it with caution, lest it be another “hoax,” as Fed Chair Jerome Powell described the behavior of inflation over the past two years.
Even if inflation really is falling, it’s still not where the Fed wants it. The CPI and the personal consumption expenditure (PCE) index, the Fed’s preferred measure, are still above the central bank’s 2% target. If the Federal Open Market Committee chooses to keep rates in the 5.25%-5.50% range at its December meeting, as we expect, the game is not over.
We believe the Federal Reserve has entered a period of “higher rates for longer” that is likely to last at least through the second half of 2024. It is up to policymakers to let the delayed impact of monetary policy be fully felt sooner. to relax her. Furthermore, Powell would like nothing more than to steer the economy toward a soft landing. He has never given up hope that America can avoid a recession, and his legacy would be strengthened if he succeeds.
This scenario should keep liquidity managers on cloud nine, even as some investors extend duration to other asset classes. Most liquid products should continue to reflect the target range with attractive yields. And as the Fed finally begins to change course, the broader sector is likely to attract asset flows if yields decline more slowly than other liquidity options, as has happened in previous periods of easing.
Liquidity in abundance
Like the Fed, the world’s major central banks appear to have regained their footing in the fight against inflation. Although they must take into account the Fed’s policy due to the dominance of the US dollar and the size of their economy, policymakers have successfully addressed the particular problems of their own countries.
This continued in November with the rest of the Big Four, which kept benchmark rates at current levels in October and November: Bank of England (BoE) at 5.25%, Bank of Japan (BoJ) at -0.1 % and the European Central Bank (ECB) at 4%. Although the wars in Ukraine and Israel have a greater economic impact on Europe than on the United States, the fight to bring inflation to around 2% is paramount.
The OECD predicts that price pressures force the BoE and ECB to keep rates at current levels until 2025. The BoJ also wants to see inflation at 2% (it is now above), but for the opposite reason. Still fearful of a return to deflation, he is content with a moderate attitude.
Liquidity products around the world have benefited from rising rates and the leadership of most central banks, including those in Canada and Australia, resulting in an adequate and stable supply of sovereign bonds. The large, high-quality corporate banks that make up much of the collateral for liquidity products have strong balances, excess capital and large reserves. Although flows to global monetary funds have not been as abundant as in the United States, they are healthy.
