The loose interest rate cycle in the United States is about to begin, and some investors believe that it will cause funds to flow from money market funds (MMFs) to US stocks, providing support for stock market growth. However, UBS Group pointed out that historical data shows that this may not be the case.
Money market funds primarily invest in risk-free assets such as short-term government bonds in the USA. Previously, with the launch of the most aggressive interest rate hike cycle in decades by the Federal Reserve, the official borrowing cost in the USA rose from close to zero in March 2022 to a range of 5.25% to 5.5%. The average yield of money market funds was pushed up to about 5.21%, and capital poured into such low-risk assets.
The current market consensus is that the Federal Reserve may signal a rate cut in September at this week's FOMC meeting. Some stock market bulls believe that the start of a loose interest rate cycle in the USA will lead to a shift of funds from money market funds (MMFs) to US stocks, providing support for a possible rise in the stock market.
But UBS Group's strategy analysts, led by Matthew Mish, do not agree. They believe that the funds in money market funds may not have such a big impact on US stocks and that the most benefited area could be the corporate debt sector.
UBS pointed out that by the end of the second quarter of 2024, the assets under management of money market funds soared to 6.1 trillion US dollars, compared with 5.4 trillion US dollars in the same period of 2023 and 3.2 trillion US dollars in the same period of 2019. Most of this growth comes from households.
UBS believes that it is important to consider the share of MMF relative to other asset classes. Since 2019, the compound annual growth rate of the US stock market and the US bond market has been 11%, which has caused the share of money market fund assets relative to US stocks or US bonds to be below the historical average level. For example, the ratio to the stock market is currently 7%, with an average of 10%; the ratio to the bond market is currently 23%, with an average of 34%.
In contrast, the compound annual growth rate of corporate debt assets since 2019 has been 5%, and the ratio of money market fund assets to such assets is currently 28%, with an average of 38%. With the future rate cut by the Federal Reserve, the potential for money market funds' assets to shift to corporate bonds is much greater.
UBS also mentioned that in the last interest rate cut cycle of the Federal Reserve in 2020, funds were rotated to fixed-rate credit, including investment-grade bonds.
UBS believes that investors should focus on investment-grade credits in banks, medical care, and other sectors, which are likely to benefit from the flow of capital in money market funds by the end of 2024 and early 2025. In the high-yield credit sector, focus may be on finance, sse non-cyclical industry 100 index, and transportation.
UBS also mentioned that in terms of risk, its analysis shows that in the case of an economic recession in the USA, high-yield bonds in the USA perform worse than investment-grade 7-10-year and 10+ year bonds, while in the absence of a hard landing, the performance of investment-grade 7-10- year and 10+ year bonds is worse than that of high-yield bonds.
Editor/Somer