$6.56T Sitting on the Sidelines, Is This Bullish?

Just last week, assets under management (AUM) in U.S. money market funds (MMFs) set a new record with an unprecedented $6.56 trillion. These funds are what market participants usually refer to as “money on the sidelines,” which can be thought of as keeping money busy and safe until better opportunities arise. Interestingly, there has been a persistent inflow to MMFs even as the odds-makers all but guarantee a Fed easing before the year’s end. In fact, it’s worth noting that a rate cut would cause yields to decline in these funds.

This is important for stock market investors because once the Fed begins lowering interest rates, a percentage of this large sum of money will probably be allocated to risk assets, particularly equities. More money chasing the same number of stocks is likely to drive prices up, which could then generate even more demand that catapults stock prices upward.

Where Did the MMF Money Come From?

The growth in MMF AUM since the end of 2019 can be divided into three distinct growth periods. The first occurred during the initial reaction to the COVID-19 pandemic. It was then that institutional inflows surged by approximately $1 trillion within a few weeks, mostly due to heightened fear and economic uncertainties.

The second period began in 2022 and was characterized by retail inflows as the Fed started raising rates. This is because savers were finally getting a return above zero. The third period of growth was marked by the regional bank crisis in March-April 2023. Here, the funds experienced both retail and institutional investors moving funds from regional bank deposits into MMFs.

Future Trajectory of MMF AUM

Looking ahead, it is unlikely that MMF AUM will quickly revert to pre-COVID levels of around $4 trillion, even if a less restrictive Fed policy commences in September, as anticipated by some economists. This is partly because rates on these funds won’t react as quickly. The nature of MMF management is to hold combined assets that have a weighted average maturity of up to 60 days, and holdings can mature as far out as 13 months. Therefore, the yield will notch down more slowly than the fed funds rate as fund investments mature and get reinvested.

Institutional vs. Retail Flows

Then there is the question of what would wind up in stocks and what is more likely to be invested in bonds or non-equities. There is a difference between institutional and retail flows into and out of MMFs, as their motivations differ significantly. Institutional funds constitute 61% of MMF AUM, while retail funds account for 37%. When reallocating from MMFs, many institutional investors are restricted to specific investment-grade bonds or other fixed-income securities. So, any flow from these pools of money is more likely to impact bond yields.

Due to this institutional demand, bond yields would likely fall, which could be bullish for retail investors looking for stock returns because it would reduce corporate borrowing costs and potentially boost net income.

Stock Market as Beneficiary

The movement of money from cash to stocks can have several immediate and longer-term effects on the financial markets. Year-to-date, the S&P 500 surged more than 18%, driven largely by the technology sector. This included significant contributions from companies like Nvidia (NVDA), which has risen 33% this year alone. This influx of capital into stocks has led to a broadening of market participation, with the Russell 2000 index (IWM), representing small-cap stocks, also seeing a notable increase of more than 10% in the past week

Key Takeaways

A huge investor rotation out of money markets and into stocks and bonds could occur when the Fed begins easing monetary policy. MMFs just set a new AUM record, which can be seen as the new high water mark for financial “dry powder” that could be used to ignite a bull run in the stock market. While money will drift back over time, the move may snowball as rates come down gradually while stock prices experience the upward pressure of more demand.