7.6 trillion yuan in funds on standby: How will the Federal Reserve's interest rate cuts reshape the market landscape?

According to the Zhitong Finance APP, as the Federal Reserve approaches its first interest rate cut in a year, Wall Street's focus is shifting from inflationary pressures to a larger potential market force: approximately $7.6 trillion in money market fund assets. According to Crane Data, this record amount has benefited from the high yields brought about by the Federal Reserve's interest rate hikes over the past year, but now faces pressure from declining yields as the rate-cutting cycle begins.

The market widely expects that the Federal Reserve will cut rates by at least 25 basis points at next week's FOMC meeting, and may even cut by 50 basis points in one go. This policy shift will gradually lower the returns on risk-free cash investments, prompting investors to reassess their allocation strategies.

Recent labor market data shows clear signs of weakness in the U.S. labor market, with rising risks of unemployment. Meanwhile, the latest inflation data, while not completely eliminating price pressures, is insufficient to prevent the Federal Reserve from initiating the rate-cutting process.

Shelly Antoniewicz, chief economist at the Investment Company Institute (ICI), stated, "The latest employment data essentially locks in the necessity for a rate cut." She expects that the pace of future rate cuts by the Federal Reserve will continue to depend on economic data, particularly employment and inflation performance.

Antoniewicz pointed out that as rate cuts begin, approximately $7 trillion currently sitting in money market funds will gradually flow into higher-risk, potentially higher-yielding assets such as stocks and bonds, as savings rates will gradually lose their appeal.

On Wall Street, there is a theory known as the "Wall of Cash," which suggests that the massive cash flow will trigger a self-propelling rise in the stock market. However, Peter Crane, president of the money fund research firm Crane Data, expressed skepticism about this.

Crane noted that historical data shows that the asset size of money market funds only declines during extreme economic recessions when interest rates are near zero, such as during the bursting of the internet bubble and the 2008 financial crisis. "Interest rates are indeed important, but they are not as critical as people imagine," Crane said. "This $7 trillion will not flow out; it will only continue to grow."

Crane also revealed that about 60% of money fund assets come from institutional and corporate cash, which has high liquidity needs and will not enter the stock market on a large scale due to interest rate changes. He estimates that at most only 10% of the funds may flow into higher-risk investment areas.

Currently, the average annualized yield of money market funds is 4.3%, which still offers significant appeal compared to the less than 0.5% rate on bank deposits.

Crane believes that even if the Federal Reserve cuts rates by a cumulative 100 basis points in the future, bringing yields down to 3%, most of the funds will still remain in money market funds. "Unless we see a return to a historical zero interest rate environment, the asset size will not shrink significantly."

From historical experience, investors place more emphasis on the yield differential rather than the absolute level. Compared to bank deposits, money market funds can still provide more competitive returns Even if the Federal Reserve announces an interest rate cut next week, the flow of funds will not happen immediately. The weighted average maturity of money market funds is 30 days, which means that the high-yield assets they hold will gradually mature over the course of a month. Therefore, in the short term, the scale of funds may even increase further, as their returns are still higher than newly issued U.S. Treasury bonds.

However, in the long term, as old assets mature and yields decline, the attractiveness of funds will gradually decrease, and some investors may reallocate their portfolios.

Todd Sohn, a technical strategist at Strategas Asset Management, suggests that investors should consider risk preferences and tax factors when making decisions about fund transfers: 1. Extend bond duration by investing in 2-5 year U.S. Treasury ETFs to compensate for the decline in short-term yields through higher coupon payments and potential price appreciation; a "Bond Ladder" ETF can be used to diversify different maturities and reduce volatility risk. 2. Increase stock allocation by considering adding small-cap or international market exposure, rather than continuing to increase highly concentrated large-cap tech stocks. Sohn reminds that the current market capitalization of the eight major tech stocks accounts for nearly 40% of the total market capitalization of U.S. stocks, so further accumulation should be approached with caution; 3. Diversify investments by allocating to alternative assets that are lowly correlated with the stock and bond markets to spread risk