As interest rate cuts approach, the US $6 trillion "ammunition" is ready to be unleashed, but the biggest beneficiary may not be the US stock market

Money market funds mainly invest in risk-free assets such as US short-term government bonds. Previously, with the Federal Reserve launching its most aggressive rate hike cycle in decades, the official borrowing cost in the United States has risen from near zero in March 2022 to a range of 5.25% to 5.5%. The average yield of money market funds has also been pushed up to around 5.21%, attracting a frenzy of funds into these low-risk assets.

The current market consensus is that the Federal Reserve may signal a rate cut in September at this week's FOMC meeting. Some stock market bulls believe that the start of a loose monetary policy in the United States will lead to funds flowing from money market funds (MMFs) to US stocks, providing support for a stock market rally.

However, analysts led by Matthew Mish at UBS do not share this view. They believe that the funds in money market funds may not have such a significant impact on US stocks, and the area that may benefit the most is corporate bonds.

UBS points out that by the end of the second quarter of 2024, the assets under management of money market funds surged to $6.1 trillion, compared to $5.4 trillion in the same period in 2023 and $3.2 trillion in 2019. Most of this growth comes from households.

UBS believes it is important to consider the share of MMFs relative to other asset classes. Since 2019, the compound annual growth rate of the US stock market and US bond market has been 11%, resulting in the share of money market fund assets relative to US stocks or US bonds being below historical averages. For example, the current allocation to stocks is 7%, compared to an average of 10%; the current allocation to bonds is 23%, compared to an average of 34%.

In contrast, the compound annual growth rate of corporate bond assets since 2019 has been 5%, and the current ratio of money market fund assets to these assets is 28%, compared to an average of 38%. With potential future rate cuts by the Federal Reserve, the potential for money market fund assets to shift to corporate bonds is much greater.

UBS also mentions that during the last rate cut cycle by the Federal Reserve in 2020, funds rotated into fixed-rate credit, with investment-grade bonds leading the way.

UBS believes that investors should focus on investment-grade credits in industries such as banking and healthcare, which are expected to benefit from the flow of funds from money market funds by the end of 2024 and the first half of 2025. In the high-yield credit sector, attention can be paid to finance, non-cyclical industries, and transportation.

UBS also notes that in terms of risk, their analysis shows that in the case of an economic recession in the United States, the performance of US high-yield bonds is inferior to US investment-grade 7-10 year and 10+ year bonds, while in the absence of a hard landing, the performance of US investment-grade 7-10 year and 10+ year bonds is inferior to high-yield bonds