Money-Market Funds Are Attracting A Lot Of Attention. There Is A Small Risk Involved.

People have aggressively moved cash into money-market funds as interest rates remain high, exactly the kind of move that is causing banks problems. Although it's not entirely risk-free, it's a smart move.

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Clearly, money funds are appealing to a large number of people. The stock market looks risky right now, and the rates on all kinds of short-term, cash-like fixed-income assets have gone up as a result. It wasn't long ago that the yield on the 3-month Treasury note reached as high as 5%, and is now at around 4.8%, compared with around 4.4% at the beginning of the year. There are similar movements and yields seen in the one-year Treasury note as well.

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The total amount of assets in money market funds, whose yields generally align with those of the market for very short-term debt, rose to a record of around $4.9 trillion recently, up from around $4.5 trillion in 2022, according to Bank of America BAC +0.88%. There has been an inflow of more than $400 billion into money market funds over the past six months, making it the largest inflow since September 2020 over that same period of time. 

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Recent Google searches for the term "money market fund" have been running at a level that is three times higher than that seen in September, according to data from DataTrek. As a result of recent spikes in short-term rates in our region, search volumes have recently reached their highest levels since March 2020, which occurred as the Pandemic began to take hold.  

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Banks have a problem in the fact that to the extent people place their cash in money-market funds, that cash is not going into bank deposits, which is the least expensive source of funding for bank loans. Thus, banks are left with an unpalatable choice to make. The banks can either offer to pay higher interest rates on deposits, or they can replace the lost deposits with higher-cost loans obtained elsewhere to make up for the lost deposits.

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Using either of these options would reduce the profit margins of lenders by reducing the gap between what they can earn by issuing mortgages and other loans and what they have to pay for funding.

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Consumers have a simpler calculus. No matter how the stock market performs next year, a 5% annual yield doesn't seem too bad.

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Nevertheless, money-market funds still carry some minimal risk. The government could default on some payments if the debt ceiling isn't raised. Money-market funds would lose value if short-term Treasury bonds fell in price, resulting in higher yields. 

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“The default of the government would be a significant problem for money-market funds, too,” according to Nicholas Colas, co-founder of DataTrek. “The likelihood of that happening is low, but there is obviously a risk." 

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Investors should learn that while some allocation to money market funds makes sense at this point, it may not be the best idea to keep everything in cash at all times.