Liquidity lowdown: How did the equity market slump affect money markets?

Last Monday’s (5 August 2024) sell-off saw some of the largest moves in equities in a single day since 2022.

The S&P 500 fell 3.0% and Europe Stoxx 600 benchmark declined 2.2%. The emerging consensus for the equities sell-off was
a) fears about the US economy following weaker than expected employment data
b) a slowdown in wage growth along with downbeat earnings and forecasts from some the worlds technology giants and
c) strengthening of the Japanese yen and unwinding of the carry trade.

Government bond yields around the globe also tumbled as investors ploughed into safe-haven assets, pushing prices ever higher. However, this intense overselling was somewhat short lived with markets rebounding sharply on Tuesday (6 August 2024), but the effects of what we witnessed on Monday were felt strongly, not least of all in money markets. One-year certificates of deposit (CDs) fell around 0.10%-0.15% overnight.

Moves of this magnitude are not often seen within such a short space of time, but the sharp repricing was seen across the whole money market curve with three-month CDs also dropping 0.03%-0.04%, but this was short lived and came back 0.02%-0.03% the following day. Overreactions to economic data are becoming more common, with money markets keen to reprice assets in response to changes in economic data and interest rate expectations. At the start of June, the market saw interest rates being cut to 4.75% by the end of 2024. Markets are now pricing in an additional cut to 4.50% by year end. Rates on money market instruments have therefore generally ground lower, but with the expectation for terminal rate being 3.00-3.50%, we believe investors will continue to see cash as a credible asset class even once the terminal rate has been reached.

Whilst markets have remained volatile during the month of July 2024, treasury bills (T-bills) have continued to be well bid in auction. Summer markets tend to be particularly volatile, and often difficult, with increased illiquidity in some areas. However, there has been increased appetite for T-bills in the secondary market as investors weigh up the benefits of holding government debt over money market assets. The spread between CDs and T-Bills has generally tightened over the month, with little pick-up in yield offered for the credit risk of holding a CD when considering the historic default rate. There are of course many reasons why this may be the case. Credit spreads can indicate how strong an economy is, and how people feel about risk. But in money markets, issuers may simply lack appetite to raise funding, thereby reducing the spread offered on CDs. But nonetheless, we believe the attractiveness of T-Bills has pushed many money market funds (MMFs) into holding a larger proportion of their portfolio in these assets. The added benefit of holding T-Bills is that they are usually highly liquid and can offer a hedge against credit risk.

Yields on six-month T-bills are now around 4.85%-4.90%. This represents a yield pick-up of around 60-70 basis points if we compare this to a short-dated gilt, and only marginally lower when compared to yields in six-month CDs. We believe those holding the Jan 2025 gilt may be looking to switch where possible into six-month T-bills for an attractive pick up in yield. In our view, it is likely that MMFs will be looking for even further supply in the months ahead.

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.