Yield on cash was especially hard to come by during the last two years’ low interest rate environment. As a result, yield had not been a point of differentiation between MMFs and bank deposits. Rate rises should change that, as they are expected to increase yield potential for cash investors and cause spreads between MMF yields and bank deposit rates to widen.
Some bank deposit rates may exceed MMF yields in the early stages of a rate hiking cycle. However, it is important to keep in mind that bank deposit rates have historically lagged rate hikes and MMF yields once a hiking cycle is underway. During the last cycle, which began in late 2015, bank deposit rates exceeded the federal funds for about a month after the Federal Reserve’s first rate hike. But by early 2019, there was about a 200-basis-point difference between the average yield on MMFs that invest in US government debt and the national deposit rate for 3M CDs (see figure 1).
This difference is largely attributable to the structural differences between MMFs and bank deposits. MMFs are diversified portfolios of highly liquid assets, while bank deposits are unsecured liabilities on banks’ balance sheets. While rate hikes are reflected in the assets held by MMFs (subject to the underlying portfolio positioning), deposit rates are dictated entirely by individual banks. This means that depositors’ yield potential is inherently constrained by banks’ balance sheet and funding needs. For this reason, our view is that investors seeking to capitalize on increases in global central banks’ policy rates should consider MMFs for their cash.
