Liquidity lowdown: will 2025 be another year of surprises?

Looking back at 2024, it was a year of multiple surprises. 

At the start of the year, the implied overnight rate or Sterling Overnight Index Average (SONIA) for December 2024 was 3.46%, but it wasn’t long before the market came to the realisation that the path to neutral rate may not happen as quickly as anticipated. Today the overnight rate remains at 4.75%. This is more than 125 basis points higher than where the market predicted it would be a year ago. 

The economy hasn’t been performing particularly well as of late. Consumer and business confidence is low, and economic growth has all but stalled. Many of the UK’s problems stem from Chancellor Rachel Reeves' October 2024 Budget, which sees businesses taking the brunt of the government’s tax rises. It may also spark a fear that increasing costs for businesses will result in job losses for workers and price increases for consumers. We also expect the Bank of England (BoE) will cut interest rates four times in 2025, with a focus on growth concerns and a likely drop in forward-looking inflation expectations. 

Yields on certificates of deposits (CDs) will naturally push lower when interest rates are cut again, as they closely align with SONIA. One-year CDs fell around 50 basis points throughout 2024, having started the year around 5.20%. These declines were expected, given SONIA’s similar drop during the same period, but we believe that money market funds can still offer attractive yields on a risk adjusted basis. Many had expected a flurry of outflows from funds as yields trended lower, but that has not materialised and we do not anticipate this to happen any time soon, even when neutral rate is reached. There is always a need for cash, and it is hard to argue that money market funds don’t have a place in investors’ portfolios. Money market funds have remained flush with cash in 2024 and remain a dependable asset class regardless of the economic outlook.

There are possible regulatory changes coming later in the year which could change the landscape of managing liquidity funds

It is probably too early to understand the potential challenges that money market investors may face in 2025. However, there are possible regulatory changes coming later in the year which could change the landscape of managing liquidity funds. The BoE is continuing to shrink its balance sheet through a combination of active bond sales and passive quantitative tightening, which may help money managers when it comes to keeping increased amounts of daily and weekly liquidity. Liquidity has been draining from the system since 2022 and there is no slowdown in the supply of gilts being sold back to the market by the BoE.

In essence, banks have demand for cash, which is also reflected in the heightened usage of the BoE’s short-term repo facility, where banks borrow cash for one week in exchange for high quality liquid assets. So while these regulatory changes may not necessarily pose an immediate problem for money managers, given the abundance of parties they can lend cash to, there will still be a lot to navigate should any material changes emerge. It is hard to be particularly optimistic about the UK in 2025, but one thing we can be sure about is that money market funds remain in pretty good shape.

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.