April 8th, 2023: Money Market Funds Record Inflows: What It Means for the EconomyOver the past few weeks, the banking industry’s ongoing turmoil and the quest for higher yields have sparked a surge of interest in money market funds. According to the Investment Company Institute, this has resulted in over $300 billion flowing into these funds, pushing assets to a record $5.2 trillion, surpassing the pandemic peak of $4.8 trillion. In contrast, deposits in all commercial banks have decreased by $1 trillion from $18.3 trillion to $17.3 trillion. What could this mean for the economy?
Treasury Secretary Janet Yellen has identified money-market funds as a potential source of risk to the banking system since the funds cannot be recirculated into the economy as loans. JPMorgan Chase CEO Jamie Dimon warned that the banking crisis has increased the likelihood of a US recession this year. “We’re seeing people reduce lending, cut back a little bit, and pull back a little bit,” he said. Although stress in the sector does not always cause a recession, he warned that “it is recessionary.”
There are indications that a slowdown is on the horizon. The Atlanta Fed’s GDP tracker shows a slower growth rate of only 1.7% in the first quarter, compared to an estimate closer to 3.5% less than a month ago. Small businesses are under the most pressure. Yesterday’s jobs report showed the lowest pace of growth in more than two years, indicating that the labor market is cooling slightly. Startups from venture capitalists raised only $37 billion in the first quarter, the lowest in three years. It’s evident that investors are adopting a more cautious approach due to the uncertain economic conditions. There has also been a significant drop in market trading volume, over 30%. The stock market has become very narrow, with only a few highly volatile stocks appreciating while the rest struggle to make any real gains.
There are several reasons why money leaving the banking system can lead to a recession. When money-market funds receive deposits, the funds are invested in short-term, low-risk securities such as government bonds, rather than in longer-term loans, mortgages, or other types of credit. This decrease in lending activity can slow down economic growth and lead to a recession. Banks have less money to lend when this money is withdrawn from the banking system, leading to a decrease in the credit supply. This, in turn, can result in higher interest rates, making it more expensive for consumers and businesses to borrow money. As a result, spending and investment may slow down, leading to a decrease in economic activity. Given the banks’ investment losses, they may tighten lending standards, making it more difficult for businesses and individuals to access credit. This can lead to a decrease in investment and an increase in loan defaults, which can further harm the banking system.
Despite all of the ongoing negative headlines, the good news is markets have remained resilient. As I mentioned a few weeks ago, investors have shifted back towards dividend-paying stocks, and large-cap growth stocks have seen the highest returns as long rates continue to fall. The expectation is the Fed will cut rates early next year and dividend stocks will once again be the only place to generate a higher income. As we approach earnings season, the market narrative is expected to shift towards how companies’ cost-cutting measures are helping to boost profits during these challenging economic times. However, the impact of reduced lending activity due to falling deposits in banks and higher money market deposits could potentially hold back economic growth.
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Over the past few weeks, the banking industry’s ongoing turmoil and the quest for higher yields have sparked a surge of interest in money market funds. According to the Investment Company Institute, this has resulted in over $300 billion flowing into these funds, pushing assets to a record $5.2 trillion, surpassing the pandemic peak of $4.8 trillion. In contrast, deposits in all commercial banks have decreased by $1 trillion from $18.3 trillion to $17.3 trillion. What could this mean for the economy?
Treasury Secretary Janet Yellen has identified money-market funds as a potential source of risk to the banking system since the funds cannot be recirculated into the economy as loans. JPMorgan Chase CEO Jamie Dimon warned that the banking crisis has increased the likelihood of a US recession this year. “We’re seeing people reduce lending, cut back a little bit, and pull back a little bit,” he said. Although stress in the sector does not always cause a recession, he warned that “it is recessionary.”
There are indications that a slowdown is on the horizon. The Atlanta Fed’s GDP tracker shows a slower growth rate of only 1.7% in the first quarter, compared to an estimate closer to 3.5% less than a month ago. Small businesses are under the most pressure. Yesterday’s jobs report showed the lowest pace of growth in more than two years, indicating that the labor market is cooling slightly. Startups from venture capitalists raised only $37 billion in the first quarter, the lowest in three years. It’s evident that investors are adopting a more cautious approach due to the uncertain economic conditions. There has also been a significant drop in market trading volume, over 30%. The stock market has become very narrow, with only a few highly volatile stocks appreciating while the rest struggle to make any real gains.
There are several reasons why money leaving the banking system can lead to a recession. When money-market funds receive deposits, the funds are invested in short-term, low-risk securities such as government bonds, rather than in longer-term loans, mortgages, or other types of credit. This decrease in lending activity can slow down economic growth and lead to a recession. Banks have less money to lend when this money is withdrawn from the banking system, leading to a decrease in the credit supply. This, in turn, can result in higher interest rates, making it more expensive for consumers and businesses to borrow money. As a result, spending and investment may slow down, leading to a decrease in economic activity. Given the banks’ investment losses, they may tighten lending standards, making it more difficult for businesses and individuals to access credit. This can lead to a decrease in investment and an increase in loan defaults, which can further harm the banking system.
Despite all of the ongoing negative headlines, the good news is markets have remained resilient. As I mentioned a few weeks ago, investors have shifted back towards dividend-paying stocks, and large-cap growth stocks have seen the highest returns as long rates continue to fall. The expectation is the Fed will cut rates early next year and dividend stocks will once again be the only place to generate a higher income. As we approach earnings season, the market narrative is expected to shift towards how companies’ cost-cutting measures are helping to boost profits during these challenging economic times. However, the impact of reduced lending activity due to falling deposits in banks and higher money market deposits could potentially hold back economic growth.