In March 2022, the Federal Reserve began aggressively raising interest rates, causing significant collateral damage to various sectors of the economy. This included impacting Money Market Funds, where a record-breaking $6.4 trillion had accumulated by the end of 2023, equal to 23% of the U.S. GDP. This surge in liquidity, known as the “Wall of Cash,” was divided into retail and institutional segments, with the retail component experiencing explosive growth.
The influx of cash into money market funds was triggered by the Federal Reserve’s rate hikes, with a direct correlation between the Fed Funds Rate and fund levels. The cash came from various sources, including stimulus programs enacted during the Covid-19 pandemic. The outflows from commercial bank deposits into money market funds coincided with the start of the rate hikes, leading to concerns about potential disruptions in the financial system once the funds are withdrawn.
The surge in money market funds raised questions about its impact on the banking system, equities, and other financial markets. Some analysts saw it as a potential source of “dry powder” that could fuel a market rally, while others warned of risks associated with the sudden movement of trillions of dollars. The historical patterns of money market fund levels and their relationship to the stock market were examined, with possible interpretations ranging from signaling an oncoming recession to suggesting a bullish outlook for equities.
While the current surge in money market funds does not seem to indicate an imminent recession, it has raised concerns about the composition of the funds’ holdings and the potential for disruptions in the bond market once the cash is redeployed into equities. The rapid response of money market investors to rising rates and the possibility of a quick influx of liquidity into the market add to the uncertainty surrounding the situation. The Federal Reserve has highlighted the risks of disruptive redemptions and runs in the financial system, underscoring the need for careful monitoring of these developments.
