US money market funds: cash is king amid banking turmoil

Cash is no longer trash. Assets invested in US money market funds hit a record $5tn this month. Investors rattled by the collapse of three US banks and a crisis of confidence in smaller regional lenders scrambled for safe, liquid alternatives to park their assets.

About $120bn flooded into US money market funds in the week to March 15, according to the Investment Company Institute. That is the biggest weekly inflow since April 2020.

A money market fund is a mutual fund that invests in short-term debt. While they are not federally-insured, they are generally seen as an ultra-safe cash substitute.

But what goes in quickly, can come out just as fast. The importance of these instruments in the financial plumbing system has prompted the Federal Reserve to step in twice in the past 15 years. New rules — aimed at disorderly runs during periods of market stress — should be unveiled in April.

The worst panic since the Great Financial Crisis is wracking western banking. That makes outcomes hugely unpredictable. But optimists believe current inflows into money market funds carry less risk than in the past.

Past bouts of instability were centred on “prime” money market funds. These invest in commercial paper (short term company debt), a key source of short-term financing for many US companies. Sudden mass withdrawals contributed to stress in the short-term funding markets.

But exposure to prime funds has been in decline. More than 82 per cent of money fund assets are now in government funds, which invest only in Treasuries or government bonds. Investors have poured nearly $145bn into government money market funds and took out $18bn from prime funds.

Another reason that should discourage investors from rushing for the exit: the relatively high returns available on money market funds. These have steadily increased since the Fed started raising interest rates last year. An index of the 100 largest money market funds run by Crane Data, which tracks the industry, shows yields have climbed on average to 4.4 per cent from 0.02 per cent at the start of 2022.

That is still running behind the pace of US inflation, which clocked in at 6 per cent in February. But these funds, absent an unreasoning stampede out of them, should still offer a decent shelter for nervous capital.