The stock market has not brought much joy, bonds are a source of much pain and inflation is worrying.
But finally, there’s a glimmer of good news for people who need a place to park their money: money market funds are finally starting to pay a little interest.
These funds are a convenient place for both individual investors and large institutions to temporarily hold money. Their returns have been very low for years and since the March 2020 crisis, they have hovered close to zero and paid investors next to nothing.
But now that the Federal Reserve has started raising the short-term interest rates it directly controls, the yields of money market funds available to consumers have also begun to rise — and will continue to rise as long as the Fed continues to raise short-term interest rates. -term rates.
“You can expect money market rates to continue rising for a while,” said Doug Spratley, head of the cash management team at T. Rowe Price. “And they’ll rise pretty quickly.”
Don’t get too excited just yet. This is not a return to the early 1980s, when money market rates rose above 15 percent along with inflation. The return on the average large money market fund is still only about 0.6 percent, said Peter G. Crane, the president of Crane Data of Westborough, Massachusetts, which oversees money market funds.
“Proceeds are going in the right direction,” said Mr. crane. “But that’s still not much, especially when you factor in inflation.”
The consumer price index runs above 8 percent on an annual basis, creating a huge gap between inflation and money market returns. That is not good for your personal wealth to say the least. Rather, it indicates that your real return, adjusted for inflation, is very negative. In other words, the longer you keep your extra money in a money market fund, the less buying power you will have.
The role of the Fed
Money market returns will not stay where they are for long. On Thursday, the Federal Reserve is likely to raise interest rates again, and money market rates should follow, with a lag of about a month.
How this is done is a bit complicated, so be patient for a quick dive into financial plumbing.
What will get the most attention on Thursday is that the Fed will raise the benchmark interest rate for the federal funds, probably 0.5 percentage points, to a range of 1.25 to 1.50 percent. That is expected to happen again in July, with further increases. Traders are betting that Federal Funds interest rates will rise above 3 percent in 2023.
But the Fed has also raised other interest rates, including one with a dismal name: the reverse repurchase agreement, also known as the reverse repo rate.
That percentage stands at 0.80 percent, but was close to the zero limit for months. Money market funds receive that rate for funds held overnight by the Fed, so it acts as a rough floor on returns.
Currently, short-term Treasury bills, with yields in the range of 0.85 to 1.05 percent, offer a practical ceiling, especially for funds holding government securities.
As I wrote when interest rates fell to near zero in 2020, money market funds’ operating expenses were higher than the income they brought in. That theoretically meant that the funds could have resorted to paying negative returns to make money, which would have resulted in fund investors paying for the privilege of parking their money in a money market fund. Negative rates did not occur in the United States. Fund companies provided expense allowances—basically grants—to keep the funds in business.
The rise in short-term interest rates has mitigated that particular crisis. Where money market fund rates go next depends on the inflation arc and the Federal Reserve’s response to it.
A place for cash
Practically speaking, many people in today’s troubled markets need good places to keep their money in the short term. In the past, I’ve noted that several options — such as bank accounts and treasury bills — seemed reasonable. Now I would add money market funds to that list, with some qualifications.
Keep in mind that money market funds, yielding aside, ran into security problems during the last two financial crises. Since then, they have been subject to stricter regulatory oversight and a series of reforms.
Many funds now only hold US government securities, and all are required to hold only high-quality debt instruments. They are all designed to prevent value swings, although they have been under pressure before and could well do so again. In any case, money market funds are safer than bond or stock funds or exchange-traded funds.
I asked Mr. Crane, who has kept a close eye on money market funds for decades, if he recommends them.
“Right now, I think they’re as safe as just about anything,” he said, adding that government-insured bank accounts “have a slight security edge.” Still, he said, if we’re ever “in a situation where cash funds lose a lot of value, you’re going to have a lot of other problems to worry about, like finding your waistcoats and making sure you have enough canned foods.”
I’d put it this way: the chances of losing money in a money market fund are slim. In another major financial crisis, it is entirely possible that they will run into trouble again, but the government has always stepped in to solve them.
There are other options for keeping money safe in the short term. In short, they include U.S. Treasury bonds, which yield an astonishing 9.62 percent, an interest rate that resets every six months. They are very safe but imperfect, especially for short term purposes. Not only are there limits to the amounts you can buy, but there are also small penalties if you cash them in within five years.
Bank accounts are extremely safe, even if the most frequently paid interest is very low. A Bankrate.com study found that the average return on a savings account in the United States was just 0.07 percent. Some online bank accounts have higher returns; in some cases they are about 1 percent. Short-term bank certificates of deposit, Treasury bills and short-term corporate bonds are also available. All these rates are rising.
The yields that money market funds currently pay are below those of Treasury bills and corporate bonds or commercial paper, but with fluctuating interest rates, the funds have a major advantage. The fund manager may exchange higher yielding Treasury bills or commercial paper as they become available. I’m not willing to spend time on that myself. I prefer to let a fund manager do the work for me.
As usual, Vanguard’s fund spending is low, which improves fund returns: The Vanguard Federal Money Market Fund has a 0.72 percent return. The T. Rowe Price Cash Reserves Fund, which Mr. Spratley manages, is close to 0.66 percent. The Fidelity Money Market Fund has a return of 0.60 percent. Almost all major asset managers offer money market funds.
Once you start looking at it, you will see that the yields increase regularly.
Who knows where they will be next week? It’s almost exciting.
When prices fall again
Keep in mind, however, that these yields are still extremely low. They don’t keep up with inflation, and if they eventually do, it probably isn’t good news either.
Just imagine the Federal Reserve succeeding in cutting inflation close to its 2 percent target in the not-too-distant future. To do this, however, it slows the economy, perhaps even into a recession. That’s no cause for celebration.
But once a slowdown becomes apparent, the Fed is likely to start cutting interest rates, presenting an opportunity for nimble money market fund managers. They can extend the maturity of their investments so that returns lag the decline in money market returns by up to two months. You could then beat inflation, but only by a small amount. And with a slowing economy, you have plenty of other things to worry about.
For now, try to enjoy the spectacle of rising money market rates without falling prey to what US economist Irving Fisher called “the money illusion.” Remember, you are losing money in real terms.
Money market fund returns are improving, yes, but as an investment they remain a bad idea.
