Talking Heads – Higher for longer bolsters outlook for money market funds

This is an audio transcript of the Talking Heads podcast episode: Higher for longer bolsters outlook for money market funds

Daniel Morris: Hello and welcome to the BNP Paribas Asset Management Talking Heads podcast. Every week, Talking Heads will bring you in-depth insights and analysis on the topics that really matter to investors. In this episode, we’ll be discussing money markets. I’m Daniel Morris, Chief Market Strategist and I’m joined today by Thibault Malin, Investment Specialist. Welcome, Thibault, thanks for joining me.

Thibault Malin: Hello Daniel, thank you.

DM: For many markets, in terms of the uncertainties around central bank policy rates, recession (or not), rate cutting (or not) this year has been more challenging than normal. If we think about how money market funds have responded to this environment so far, they’ve reacted to the rate hikes delivered by the central banks, but the concern is now if and when rates start to decrease, how is that going to affect the performance of money market funds?

TM: It is true that money market funds’ performance is highly correlated with the rate environment as they are very short-term products. Their rate and credit durations, however, are managed actively, which means that whatever the economic and rate environment, portfolio managers have ways of adding value versus their benchmarks.

This is a strength of money market funds. If we look at periods like 2014 to 2016, when the European Central Bank had to cut its rates below zero, money market funds were able to respond to this through active management of their rate and credit durations.

We do not anticipate rate cuts in the coming months – it may happen in 2024. If rates start to fall, we will adapt our investment strategies to seek to continue to outperform our benchmarks, even in a negative rate environment.

DM: Alongside predicting what’s going to happen with short-term interest rates, there is an entire regulatory framework that affects money market funds. How will that evolve in the months and year ahead?

TM: The current regulation entered into force in 2019 and was scheduled for review in 2022. This summer – one year late due to the geopolitical conflicts that the European Commission (EC) had to deal with – the EC released its report on the functioning of the money market fund regulation.

The idea was to review whether money market funds’ liquidity was sufficient to meet all the requirements alongside their rate credit durations. With the challenging environment we have had over the past four years – the real-life stress test of the Covid crisis, the liquidity crisis in March 2020, the changing policy rate paradigm across the euro, sterling and US dollar, and the credit stress in 2023 after the US regional banks crisis – the regulators had many indicators to analyse.

It appears that the regulators now deem money market funds resilient enough to continue to be sold and to perform under the current regulation. More indicators may be added after the end of the current EC presidency at the end of 2024; there could be another review that might add new liquidity requirements for money market funds. But as of now, it seems regulators and asset managers agree that money market funds are extremely resilient.

DM: When the central banks do eventually start cutting policy rates, are we likely to see redemptions from money market funds as soon as that starts?

TM: It is true that money market funds have received subscriptions since we have had positive rates – in particularly high rates – but not that much, actually. We had a lot of subscriptions as soon as we entered the positive rate environment at the end of 2022, but this year, from January to August, we had about EUR 70 billion-worth of inflows into European money market funds across all currencies. That is not so high considering it is a market that totals more than EUR 1 600 billion.

Many types of clients, such as insurance companies and asset managers, have subscribed to money market funds for different reasons. They have found money market funds attractive in a situation where we have an inverted yield curve, making it potentially better to invest for the short run as it currently outperforms long-term investments. These investors have started to redeem money market funds over the past few weeks to invest back in medium or long-term assets as we approach the end of this hiking cycle.

However, it is important to mention that even if policy rates are cut in 2024 or 2025, it is unlikely that we will get back to the rate environment of early 2022, which should mean that money market funds remain attractive in terms of potential performance, even compared to other medium or long-term products, and to all type of clients.

In the current environment, we are still seeing many clients with a renewed interest in money market funds, particularly the retail and private banking sectors, where it generally takes more time to adapt to the different economic cycles.

DM: Thibault, thank you very much for joining me.

TM: Thank you, Daniel.