If demand for cash is a proxy for uncertainty, the U.S. has never before been gripped by such doubt.
Since social distancing restrictions shut down much of the U.S. economy in March, an unprecedented $1.08 trillion has flooded into U.S. money market accounts, which bulged with a record $4.77 trillion in the week ended May 6. Even during the global financial crisis in 2008 and 2009, that figure had never previously surpassed $4 trillion.
The record demand for cash has come from both Wall Street and Main Street as investors sold equities and other assets considered less safe and companies seek to hoard cash and cut expenses during a period of unparalleled economic uncertainty caused by the coronavirus pandemic. Such was the volume of cash flooding into the most liquid money market funds in March that the Federal Reserve was forced to intervene.
"In this environment, still with a lot of uncertainty, people just want to be holding cash," said Sean Collins, chief economist at the Investment Company Institute, or ICI. "Cash is king."
From April 2010 to November 2018, cash in U.S. money market funds never rose above $3 trillion and averaged about $2.7 trillion, according to data from ICI, an association representing investment funds. In mid-December 2018, cash in money markets crossed the $3 trillion threshold and increased steadily through the end of 2019.
Then as economic anxiety fueled by the spread of the coronavirus increased this year, so did flows into money market funds, which hold short-term debt instruments, both at the wholesale and retail level, which have very low risk, but offer relatively low returns. Due to their reputation for investment safety, total assets in money markets climbed from $3.62 trillion in the first week of February to nearly $4.77 trillion for the week ended May 6.
Cash in retail money market funds — sold primarily to the general public, including offerings that are part of employer-sponsored retirement plans and variable annuities — has increased by $138.7 billion, or about 9.7%, over the past 10 weeks, ICI data shows.
Meanwhile, cash going into institutional money market funds, which are sold primarily to institutional investors or accounts and have a high minimum investment, jumped by $946 billion, or about 42%, over those 10 weeks.
By comparison, assets in money market funds rose by $780 billion, or almost 25%, at the height of the Great Recession, peaking at $3.92 trillion.
The situation then and now are radically different, said Peter Crane, president and CEO of Crane Data, which tracks money market mutual funds. "The uncertainty over economic damage is magnitudes larger in the current environment," he said.
As states and countries tentatively reopen, it is as yet unclear whether they will be forced to retrench amid a second wave of coronavirus infections, when and if a vaccine will be developed and how quickly an effective treatment can be brought to market. With a record U.S. unemployment rate of 14.7% in April that is predicted to reach beyond 20% in the coming months, the answers to those questions are crucial in determining the long-term damage to the economy.
While stock markets slumped in March, which included some of the biggest one-day drops in history for the S&P 500, not all the cash flowing into money markets has come from equities.
Total outflows from equity funds in March reached nearly $25.9 billion, just a fraction of what was flowing into money market funds, according to ICI data. That outflow rate is not unusual for equity funds, which saw nearly $17.9 billion of outflow in February and averaged $16.6 billion in monthly outflows in 2019, according to ICI data.
A large amount of the money market inflow also likely from companies that have drawn down their lines of credit and companies simply putting aside cash due to the uncertainty ahead, said Mark Stoeckle, CEO and senior portfolio manager at Adams Funds.
"They've put off capex, they've put off other investments, and they're still generating cash flow," he said, adding that they are holding on to cash and delaying spending on buildings, new equipment and other projects.
Part of the move toward cash may have been accelerated by the Federal Reserve's decision March 15 to slash its federal funds rate to a target range of zero to 0.25%, said Mike Hennessy, founder and CEO of Harbor Crest Wealth Advisors. In the first full week after that move by the Fed, total assets in money markets crossed the $4 trillion threshold for the first time and climbed 7.3% from the previous week, according to ICI data.
"With nominal policy rates at zero and banks adjusting federally insured deposit rates in kind, money markets offer some incremental yield while implicitly providing capital preservation," he said. "So market participants can have their cake and eat it, too — capital preservation with marginal, minuscule but non-zero yields while enjoying the fruits of the Fed's asset expansion via a forced crowding-out of risk-free assets in place of riskier assets," Hennessy said.
While the Fed may have been partly responsible for the stampede into money market funds, it also came to the rescue when that sudden movement led to dislocation within the space.
Dash for liquidity
As fear gripped the economy in March, investors didn't want any market fund; they wanted the safest and most liquid ones. That meant a big surge of cash out of so-called prime money market funds, which invest mainly in floating-rate debt and commercial paper from corporations, and into government money market funds, which primarily hold government securities or repurchase agreements collateralized by U.S. Treasury securities.
The influx pushed down Treasury bill and repo rates, forcing some government money market funds to stop accepting new money and close to new investors in March, according to a May 12 Bank for International Settlements report.
Conversely, prime money market funds, seen as less liquid than government money market funds, saw a spike in redemptions, as investors sought more liquid funds, the report found.
The issues for both government and prime money market funds were only alleviated after the Fed on March 18 announced the Money Market Mutual Fund Liquidity Facility, which was created for the Fed to extend loans to dealers to purchase eligible assets from money market funds, according to the BIS.
Main Street blues
The movement of so much cash into the money market will likely come at the expense of broader economic growth, said Crane.
"The first thing that everybody does when they're unsure about the future is raise cash. The second thing you do is cut expenses to keep your cash flow robust going forward," Crane said.
As to when flows might reverse, no change is expected until some of the uncertainty has receded, said Adams Funds' Stoeckle.
"I don’t think there is going to be an all-clear switch, which is part of the challenge," Stoeckle said. "Whatever normal is, we will see money coming out of money markets, back into the market, but I think it's going to be over time. My fear is we don't really appreciate how deep this is."