Author: Fan Zhijing

After the financial turmoil triggered by the collapse of Silicon Valley banks, Federal Reserve data showed that deposits at small banks fell nearly 2 percent in a week. In addition to deposit transfers, cautious investors have fled volatile markets in search of more liquid alternatives, many of which have flocked to another financial asset, money funds.

However, monetary funds are not without risk, and Bank of America believes that a new bubble is forming, but now is not the time to return to the stock market.

Safe-haven demand detonates monetary funds

Money market funds are widely regarded as one of the safest and least risky investment options. In recent weeks, uncertainties such as the banking turmoil and the Federal Reserve's interest rate hike have flooded into it. The U.S. Monetary Fund invests in short-term marketable securities such as government bonds, certificates of deposit, and high-grade commercial bonds. Compared to equity funds, its main goal is to provide investors with a relatively stable rate of return that is higher than traditional savings.

The latest statistics show that money market funds have increased by about $4000 billion since the Fed began raising interest rates last year. In the past week alone, inflows have exceeded $2000 billion, pushing the total size of the fund to a record $5 trillion. It is reported that most of the new funds in the past week came from institutional investors, with cumulative net purchases of more than $1000 billion, almost 5 times that of retail investors.

Still, retail investors may soon pick up the pace. Goldman Sachs predicted in a report last week that individual U.S. investors could sell as much as $1.1 trillion in stocks this year, instead putting that money into money market assets.

Bob Schwartz, a senior economist at Oxford Economics, previously said in an interview with the first financial reporter that financial markets are still volatile, and concerns about the banking crisis once exceeded high inflation, "Although the event is not expected to pose a systemic risk to the banking system and the overall economy, the turmoil is not over and the uncertainty is high." ”

But monetary funds are not without risk, and the larger the size of the funds, the sudden, large sales could trigger a liquidity crisis – the fund may not have enough cash to meet these redemptions. In fact, monetary funds are deeply linked to the financial system, and the risk level is similar to that of banks. At the beginning of the epidemic in 2020, there was panic in the US monetary fund market, forcing the Federal Reserve and the US Treasury to intervene, and the US Treasury subsequently updated its regulatory requirements.

It is worth mentioning that the US Securities and Exchange Commission (SEC) is expected to publish new proposals on protecting the safety of investors' funds next month. The Federal Deposit Insurance Corporation (FDIC), a U.S. government agency, insures bank deposits, but does not guarantee funds invested in money market funds. Due to the holding of short-term marketable securities, asset prices are unusually sensitive to changes in interest rates. Investing in commercial debt means that a debt default would also result in asset impairment if there was a severe recession in the economy.

As the Fed continues its rate hike cycle, recession fears remain high. Fed interest fund futures showed that funds expect the Fed to cut interest rates by at least 50 basis points by the end of the year, and Goldman Sachs this month further raised the probability of a US recession to 35%. Schwartz told CBN that policymakers face an uphill battle to maintain financial stability while reducing inflation. As the cumulative effect of rate hikes gradually becomes apparent, he expects the US economy to face a mild recession in the second half of the year, with a peak-to-valley loss of about 1% of GDP.

Is there risk or opportunity behind the boom?

In the eyes of Michael Hartnett, chief strategist at Bank of America, the fast-inflating money fund is a new bubble.

Hartnet statistics found that the last two surges in money market fund assets were in 2008 and 2020, when the Fed cut interest rates sharply. This time is different, and that is that inflation and labor market conditions, not only in the United States, but also in other industrialized countries, remain unusually strong.

He believes that the surge in lending in the Fed's emergency discount window has historically occurred near the lows of the stock market, but now is not a great opportunity to enter the market. "When banks use the emergency discount window to borrow from the Fed, this leads to stricter lending requirements for banks, followed by a credit crunch, which leads to a breakdown in optimism among small businesses." Because small companies provide two-thirds of U.S. jobs, the labor market is affected. In addition, investors are concerned about the lack of policy coordination between the Fed and Treasury to prevent a run, which could further exacerbate bearish sentiment in equities. He said.

Bank of America statistics found that in the seventies and eighties of the last century, when the Fed was also facing huge inflationary pressures, U.S. stocks tended to continue their decline after the last interest rate hike, and the Dow fell by an average of 3.4% in the following three months, and the decline expanded to 5.6% half a year later.

So Hartnett advises investors to sell at the end of the rate hike cycle, because the end of a bear market tends to be more dangerous. With a combination of historical, policy and recessionary factors, he expects U.S. stocks to repeat their mistakes and hit new lows in the next three to six months. "Bonds and stocks are too greedy for rate cuts and not afraid of recession enough."

Similarly, Micheal Wilson, Morgan Stanley's chief U.S. equity strategist, who had previously flipped more, also warned in a report released on Monday that the stock market faced the risk of a sharp decline. He cited the decline in earnings expectations so far this year from the previous two quarters, suggesting that performance has not yet bottomed out. Given that the market still expects a sharp recovery in profits in the second half of the year, investors are still not "fully aware" of the threat of profit margins under high inflation.