Liquidity lowdown: Opportunities in rate uncertainty

Cash is a key component of sensible portfolio risk management. Money Market Funds (MMFs) have the ability to provide liquidity and security making them highly useful for a number of investors.

They can help to mitigate adverse economic effects where other asset classes cannot, but with rates still near their highest levels for a decade, cash investors have a lot to think about. Current cash rates remain above the level of inflation, offering investors positive real yields, but a lot has happened in the past month and markets have at times, been unpredictable. However, it is exactly this level of market unpredictability which leaves us to believe the option of MMFs should not be discarded just yet.

Markets are widely expecting UK base rates to fall this year to around 4-4.50%, which by historic standards is more ‘normal’ compared to the momentous lows we saw following the financial crisis in 2008-2009. February’s Bank of England (BoE) meeting saw Governor Andrew Bailey keep rates on hold, but rate cuts are now under consideration for the committee. Although independent of the government, this being an election year will add to the pressure to reduce rates.

However, with a current inflation rate of 4% – double the BoE’s target – we believe that more evidence that inflation is on course to meet the 2% target will be needed before we are all graced with the first rate cut since the start of the pandemic. Despite the UK having a relatively poor outlook and inadequate growth, the idea that rate cuts may not happen as quickly as market pricing suggests is certainly starting to disseminate. Recent labour market data in the UK and US has been much stronger than expected, which leaves us debating the timing of these rate cuts.

Even when rates do fall, investors will inevitably see a lag between falling base rates and yields achieved on MMFs. This is because MMFs are actively managed, and a manager invests in longer maturity assets to take advantage and ‘lock in’ more favourable rates. However, yields would then settle lower, and more in line with rate set by the BoE. Anecdotally, we are seeing investors use blended liquidity strategies – a combination of longer and shorter duration products to benefit from higher yields whist maintaining liquidity.

The picture for 2024 most certainly looks interesting for MMFs. Despite some intra-month volatility, one year Certificate of Deposits are still achieving yields of over 5%. The additional yield pick-up investors expect from buying longer duration CDs is not really being seen in the market at present, as rate cut expectations are being felt in full force. However, where there is volatility, there is opportunity, and we are certainly not short of that. We think that falling energy prices will push inflation lower in the in the first half of this year, before it could then rise again later in the year. We feel there is the possibility of more persistent inflation which would make the BoE’s job much harder as they seek to bring inflation back to its 2% target. But with so much potential uncertainly this year, does cash still feel like a sensible asset to consider? I’m inclined to say yes.

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.