With its latest cut, the Federal Reserve has now lowered its benchmark interest rate by a full percentage point since September—and more cuts are expected. How might this affect you?
If you’re among the many investors with excess portfolio cash in money market mutual funds, it may be time to consider moving that money into other assets. A key reason: Yields on money market funds historically have tracked the Fed’s rate path, meaning these products are likely to return less going forward. Here’s what to know and how you can prepare.
Higher Money Market Fund Returns Likely Won’t Last
Remember, short-term rates remained near zero for a lengthy period after the 2007-08 financial crisis, with money market funds typically offering relatively paltry returns during this time. However, as the Fed rapidly hiked its policy rate starting in March 2022 to combat decades-high inflation, yields on these low-risk funds surged to their highest levels in years, in many cases surpassing 5%, making them competitive with riskier assets like stocks.
With the rate rise, money market assets under management has soared, totaling more than $7 trillion for the first time ever in November 2024.1
Now, with inflation having receded, the Fed is expected to keep lowering rates. After cutting by a half percentage point in September and a quarter point in November, Fed officials slashed the policy rate another quarter point in December to a target range of 4.25%-4.50%. Their December projections show the rate declining to around 3.9% by the end of 2025 and 3.4% in 2026—down markedly from the 5.4% peak reached in July 2023.
That likely means returns on money market funds will drop steadily from here, as their yields historically have moved in tandem with the fed funds rate. Looking at just the last two rate-cutting cycles, money market yields:
- Plummeted from 4.3% in September 2007 to 0.9% by December 2008, as the Fed cuts its rate more than 5 percentage points to near zero.
- Fell from 1.8% in July 2019 to 0.7% in March 2020, as the central bank lowered the rate more than 2 percentage points, again to near zero.
What to Do With Money Market Fund Investments Now?
It may be a good time to speak with your Financial Advisor about other opportunities in the fixed income markets. For example, reallocating money from short-term cash equivalents, such as money market funds, to fixed income with longer durations may allow investors to lock in current attractive yields on assets that are still relatively low risk.
Keep in mind, Fed rate cuts have typically weighed less on longer-duration fixed income yields than on cash rates. Our team’s analysis shows that U.S. investment-grade bonds historically have averaged higher returns than cash equivalents during the periods between the end of Fed rate hikes and the end of Fed rate cuts—where we are currently in the cycle. Examples:
- Between June 2006 and December 2008, U.S. investment-grade bonds returned 6.8% annually versus cash’s 3.7%.2,3
- Similarly, from December 2018 to March 2020, annualized returns were 10% for bonds versus 2.2% for cash.2,3
Morgan Stanley’s Global Investment Committee recently recommended increasing allocations to high-quality investment-grade bonds while paring exposure to both short-term fixed income and long-term Treasuries over a “tactical” 12-month timeframe. These moves aim to achieve a “neutral” duration, meaning bond sensitivity to interest rate changes, measured in years, is neither too long nor too short relative to their benchmark.4
Some investors may also want to consider professionally managed fixed income accounts, which offer the possible benefits of:
- Active securities selection to help optimize returns and manage risk in a diverse and complex bond market.
- “Tax-loss harvesting,” in which declining assets are sold to offset potential gains in other investments held in your taxable accounts, which may help lower your tax bill.
Keep Your Financial Goals In Mind
To be sure, cash and cash equivalents like money market funds still play important roles for investors—for example, in supporting day-to-day spending needs, savings goals and even strategic allocations in your portfolio, where such assets may act as diversifiers or risk reducers.
Ultimately, the amount of money market assets you hold should reflect your personal financial goals and investment strategy—not simply what the interest-rate environment might be doing at a given moment.
Talk to your Morgan Stanley Financial Advisor to determine the right strategy for you in the context of your goals-based plan. With Morgan Stanley’s Total Tax 365, your Financial Advisor can help you consider tax-efficient fixed income strategies that align with your financial goals and may help you reduce the impact of taxes on your investments.
