Has the floor been raised for the money markets?
Yields have descended since the peak of 2023 but may settle at more competitive levels than before that spike.
There are essentially two ways an extraordinary development can play out: reverting to the mean or creating a new status quo. In finance, the latter is rare, but we believe 2026 is shaping up to be just that for the money markets.
Many would agree that the collective performance of stable value products since mid-2022 has indeed been extraordinary, riding on the back of Federal Reserve rate hikes, and rising to their highest level in decades. The high watermark for yields came the following year, with the target fed funds range reaching 5.25-5.50% and the Crane 100 Money Fund Index touching 5.20%. Funds poured into money market funds, pushing assets under management (AUM) to record highs.
But here is where it gets interesting. Logic would say that flows would reverse when the Fed pivoted to lowering rates. Yet even after 150 basis points worth of cuts since 2023, industry money fund AUM have continued to grow, hitting new highs in February of $7.8 trillion according to iMoneyNet and $8.2 trillion according to Crane Data, which calculates its figure differently. As we have said before (Slow and steady), this is in part due to how the laddered structure of money funds has kept yields above the direct Treasury market. But that might not be the entire picture. We are two and a half months past the last rate cut on Dec. 17 and inflows have continued. Furthermore, investors typically redeem a portion of their money market funds in the first quarter of a given year in a reversal of the seasonal surge in December and in preparation for upcoming tax payments. Not last year, as assets increased over those three months. And likely not this year, either, if March follows January and February’s inflows.
What’s happening? We think investors like the “new normal,” realizing that liquidity yields might remain competitive even if the Fed lowers rates by half a percentage point this year as it projected in December. This is not important “just” because of the return, but because cash management tends to work best when yields are fairly steady, as seeking stability is the name of the game. We think, and the inflows seem to back up, that investors appreciate the potential sustainability of the "benevolent ordinary" yields as much as they did the heady returns of 2023, which the Fed never conceived as long-lived. This could be wishful thinking, but we would not be surprised if stable value products retain their current widespread popularity for a long time.
And let’s not forget the uncertainty pervading the Fed’s future, the US economy and geopolitics, a collective negative vibe that often sends investors to safer harbors.
Not that you should expect most cash managers to rest on our laurels. We at Federated Hermes are a conservative bunch. Despite the inflow this year, we will consider increasing liquidity to accommodate the expected withdrawals on tax days in March (corporate) and April (individual). The new normal does not mean one should forget the good habits that helped you get there.
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