US money market funds turn defensive with Fed rate outlook uncertain

Managers have been deploying some of those inflows into floating-rate notes (FRNs), whose payouts change with the market, unlike typical fixed-rate debt. Treasury FRN holdings rose by $32 billion at the end of June to a record $523 billion. "This positioning suggests that money market managers are increasingly favoring floating-rate exposure to capture elevated three-month T-bill yields," said Angelo Manolatos, a macro strategist at Wells Fargo. "You're not taking duration risk, so if the Fed hikes, your note will reset higher," he added, underscoring the defensive nature of the strategy and referring to a measure of interest rate sensitivity. Funds also increased their use of repurchase agreements, or repos, lending cash to dealers in exchange for securities that the dealers later buy back. As of June 30, repo balances had climbed by $68 billion to $3.06 trillion, representing 37.2% of total fund holdings, according to Crane Data. Yet the appeal of overnight repos has diminished in recent weeks, analysts said. Reserve management purchases by the Fed have injected cash into funding markets and reduced the amount of available collateral, weighing on repo yields. As a result, money market funds face a difficult balancing act. "Money market funds right now are caught between a rock and a hard place," said Gennadiy Goldberg, head of U.S. rates strategy at TD Securities. "They want to be shorter in their weighted average maturities because of the risk of Fed rate hikes, but rates at the very front end of the curve, like repos, are still a bit soggy." That leaves fund managers choosing between accepting unusually low overnight yields or extending maturities and risking being locked into lower returns should Treasury bill yields move higher. "That's really the thing we're watching," Goldberg said. The shift toward shorter and more flexible investments coincided with a reduction in Treasury bill holdings, data showed. Money funds cut their T-bill allocations by $96 billion at the end of June to $3.3 trillion, according to Crane Data, although bills still accounted for 39.9% of their total holdings. More broadly, Manolatos said money funds have limited their exposure to longer-dated bills while increasing allocations to repos, a move designed "to position defensively in a potential rising rate environment." U.S. interest rate futures currently imply one Fed rate hike in 2026, likely at the December policy meeting, with nearly an 80% probability, according to the CME FedWatch tool. Money market funds are taking a more cautious approach in their portfolios, reflecting lingering uncertainty about the U.S. Federal Reserve's rate policy path, the latest industry data show. Weighted average maturity — the average time until securities held by a money market fund mature — fell to 38 days for the week ending July 10 for the Crane Money Fund Average, a broad industry measure, from 42 days a month ago. The same figure fell to 40 days this month from 44 days in June in the Crane 100 Money Fund Index, which tracks funds holding the vast majority of industry assets. The move toward shorter maturities underscores the murky outlook for Fed policy. A dovish Chair Kevin Warsh could find himself at odds with more hawkish Federal Open Market Committee members, although softer-than-expected inflation readings bolster the case for rate cuts or an extended pause. Fund managers typically shorten portfolio maturities when they anticipate higher interest rates. Shorter-dated securities mature more quickly, allowing managers to reinvest at higher yields if the Fed raises rates. Locking in three- or six-month Treasury bills ahead of a rate hike can leave investors stuck with lower yields as rates move higher. That caution comes as money market fund assets continue to attract cash. Assets climbed to a record of nearly $8 trillion in the first week of July, according to data from the Investment Company Institute.

US money market funds turn defensive with Fed rate outlook uncertain

Inflows favor floating-rate notes and repos

Treasury bill holdings decline while rate-hike bets remain

Money funds shorten maturities as Fed outlook stays uncertain

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