The Federal Reserve's interest rate cut may stimulate $2 trillion to withdraw from money market funds; where will the immense wealth flow?

Torsten Slok, the chief economist of Apollo Global Management, believes that as the Federal Reserve continues to lower interest rates, the motivation for investors to shift cash into high-yield assets is increasing, and the influx of funds into money market funds may see a reversal.

In a note to clients on Tuesday, Slok wrote, “Now that the Federal Reserve is cutting rates, where will the newly added $2 trillion in money market accounts go?” He cited the funds that have flowed into money market funds since the Federal Reserve began raising rates in March 2022. He stated that the Fed's rate hikes injected $2 trillion into money market accounts from March 2022 to September 2024.

Slok said that now that the Federal Reserve has started to cut rates, these funds are likely to flow out of these accounts and into higher-yielding assets. However, this rotation may not necessarily benefit stocks and could instead lead to inflows into the credit market. He said, “The most likely scenario is that these funds will leave money market accounts and flow into high-yield assets, such as credit, including investment-grade private credit.”

Earlier this year, Slok had warned of similar fund outflows, even as investors continued to pour in, and he maintained his stance. In an earlier report, Slok noted that the credit market seems prepared for further inflows post-election. He stated, “We expect credit fundamentals to remain strong. This, combined with higher total yields and a steep yield curve, should continue to attract funds into the credit space, thereby supporting valuations.”

However, even as the Federal Reserve has lowered rates in its last two meetings, funds have continued to flow into money market funds, which may reflect that these funds tend to reduce payouts to investors more slowly than banks. Last week, the assets of money market funds swelled to $7 trillion for the first time, dispelling speculation that once the Federal Reserve began to lower rates from their highest levels in over 20 years, investors would withdraw cash.

As of November 18, the seven-day yield of the Crane 100 Money Fund Index, which tracks the 100 largest funds, was 4.46%, slightly below the lower limit of the federal funds rate.

Slok's predictions may disappoint stock bulls, who hope that outflows from money market funds will drive a new rally in the stock market.

Meanwhile, Goldman Sachs recently stated that due to the Federal Reserve's accommodative policies and a strong economy supporting a favorable late-cycle environment for risk, investors should still favor stocks over bonds. Analysts said in a report last month, “In a late-cycle context, stocks can deliver attractive returns driven by earnings growth and valuation expansion, while total returns in credit are typically constrained by narrowing credit spreads and rising yields.”