Liquidity lowdown: what does the uncertainty around rate cuts mean for yields on money market funds?

Money markets have been at the mercy of divergent economic data lately, with the Consumer Price Index (CPI) accelerating sharply to 3.0% in January 2025, the highest level in almost a year.

The largest contributors to this inflation increase were transport costs, notably air fares, which are notorious for being volatile, and motor fuels. CPI Services year-on-year fell slightly to 5.0% from 5.1%, while CPI Core year-on-year remained level at 3.7%. Despite these figures, although gradual, the improvements in both indicators have been promising. This follows the Bank of England's (BoE) decision to cut interest rates to 4.50% from 4.75% at the start of February 2025, despite inflation remaining above its 2.0% target and projected to remain high for the rest of the year due to high energy prices.

One of the most notable and talked-about concerns at the moment is the effect of Trump's tariffs on global growth and inflation. The UK does not appear to be in as much of a precarious position as some other countries, with a deal between the UK and US a likely possibility. However, sparking a global trade war reaps few winners and has the potential to put upward pressure on prices. Although the US is one of the UK's largest trading partners, exporting around £60 billion worth of goods each year to the US, this only represents around 2.2% of the UK's GDP, which should limit the overall effect on the UK economy. However, we are still in the early stages of understanding what all this means and the resultant impact it might have.

The big question now for money market funds (MMFs) is when the BoE will next cut interest rates amidst a constant abyss of uncertainty, and what that means for the yields on MMFs in general.

 The recent decline in yields has not presented an issue for most MMFs

Yields on certificates of deposit (CDs) have gradually been drifting lower and fell by up to 4bps throughout February 2025. The trend has been gradual and can be handled well by MMFs, which invest in short-dated money market instruments and government debt. The risk of having to reinvest cash at significantly lower yields is somewhat negated when market moves present gradually. Given the nature of the short-duration assets which an MMF holds, the recent decline in yields has not presented an issue for most MMFs.

At present, the money market curve, which shows the relationship between yields at different maturity points, is relatively flat. In practice, this means that investors can invest in a CD that matures in three months or one year for a very similar yield. This demonstrates that market-implied rates are falling, with the market currently expecting just two interest rate cuts, or 50bps (0.50%) of interest rate cuts, by the end of 2025. However, even with fewer interest rate cuts being priced into markets, some issuers of CDs are reluctant to issue longer paper at levels deemed by most money managers to be attractive. This has resulted in some MMFs holding shorter paper at more attractive, fairer levels. This may be due to a lack of appetite to issue because of general market uncertainty or just a lack of any requirement for longer-term funding. Notwithstanding the heightened level of uncertainty, unpredictability and the state of the broader macro environment, we believe that yields on MMFs still look very attractive in the context of other asset classes.

For professional investors only.  This material is not suitable for a retail audience. Capital at risk. 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.