Liquidity is oxygen for a financial system. – Ruth Porat
While the Federal Reserve’s current expansionary monetary policy supports the broader market and the economy, it isn’t helping out yields. Rates are low and struggle to maintain any move back up, as shown in the graph below. No upside is in sight as, according to Federal Reserve Chairman Jerome Powell, the Fed is “not even thinking about thinking about thinking about” raising rates.
Risks to low rates
You may be asking yourself, what’s the harm in low rates? After all, low rates prompt more borrowing and can bolster economic expansions. But rates are so low, even Treasury ETFs are generating negative returns, as shown below.
Rates this low are disastrous for money market funds. Recall, money market funds are mutual funds that invest in highly liquid, short-term instruments. A money market fund’s goal is to offer high liquidity and low risk yet still providing yield.
Breaking the buck
As a mutual fund, money market funds trade to Net Asset Value (NAV) with money market funds specifically aiming to maintain a NAV of $1. If a money market fund’s NAV falls below $1, it is called “breaking the buck,” and if not rectified, this can trigger a wave of redemptions that force the fund to liquidate. In 2008, the well-known Reserve Primary Fund broke the buck as it held obligations from Lehman Brothers when it filed for bankruptcy. The subsequent liquidation of the Reserve Primary Fund sent shocks throughout the rest of the market.
As regulations have tightened in the aftermath of the 2008 financial crisis, money market funds under pressure today are waiving fees or simply shutting down. Managers of the T. Rowe Price Cash Reserves Fund recently waived fees to avoid yield negative returns. Fund giants Vanguard, Northern Trust, and Fidelity have recently closed funds.
Money market assets
The number of holdings in money market funds is staggering, with total money market holdings peaking at over $5 trillion earlier this year. In contrast, for most of this decade, total holdings were closer to $3 trillion. The total holdings are on the decline in the third quarter of 2020, though still well above historical levels. The chart below shows the total money market holdings over time.
Source: Federal Reserve
Searching for safety
Instead of parking liquidity in money market funds, I’d suggest you consider the Case For Gold I recently made. Specifically, I’d recommend using the iShares Gold Trust ETF (NYSEARCA:IAU), which enables you to hold physical gold without the encumbrances of transporting and storing the metal. Gold can be a reliable inflation hedge, as excess central bank liquidity is likely to increase inflation expectations. Also, gold functions well during heightened volatility, making it an attractive place to hold funds until volatility settles down after the election.
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Read More: Money Market Fund Closures Signal Trouble