Cash doesn’t always come from the sidelines: Morning Brief

This is the conclusion of today’s Morning Brief, which you can read Sign in Delivered to your inbox every morning, along with:

The Federal Reserve kept interest rates at decade-long highs for more than a year. Investors took notice and poured money into money market accounts, seeking returns that hadn’t been available in more than a decade.

But since the Fed cut interest rates by half a percentage point on September 18, flows into money market accounts have not stopped. In fact, research from Crane Data provided to Yahoo Finance through Oct. 10 shows that money market fund assets have increased by about $180 billion since the Fed began cutting interest rates.

This reveals several truths about the rise of “cash on the sidelines,” which some argue could be a reason the stock market rally continues.

First of all, it could be a nod to the uncertainty some feel about how things will pan out next year.

On Friday, David Kostin, chief equity strategist at Goldman Sachs, wrote in a note to clients that “history does not particularly support expectations of a cash-to-equity rotation.” Kostin’s research shows that since 1984, in the top three , six and twelve months after the start of the Fed’s austerity measures, inflows into money market funds are greater than into stock or bond funds.

Kostin expressed a view we’ve written about in the past, noting that whether or not stocks see inflows after rate cuts has more to do with why the Fed cuts rates than with the rate cuts themselves .

“Money market funds have historically seen inflows following interest rate cuts regardless of the economic backdrop,” Kostin said. “On the other hand, equity funds typically experienced inflows when the U.S. economy avoided a recession and outflows when the U.S. economy entered a recession shortly after the austerity cycle began.”

This would tell us that some people who have cash may just be waiting. Just because the Fed is cutting interest rates doesn’t mean money has to go to the sidelines and come into play.

The continued rise in money market funds is also a reminder that while interest rates are lower than they were a month ago and are expected to fall further, they are still higher than they have been in years. For example, a Fidelity Government Money Market Fund currently offers an average annual return of more than 4.5%, compared to the 10-year average of about 1.4%.

“Right now, interest rates are just good enough and Americans are just nervous enough that cash looks like an attractive asset,” Callie Cox, chief market strategist at Ritholtz Wealth Management, told Yahoo Finance.

The story continues

Cox noted that this phenomenon doesn’t always last long. Since 1980, on average, fund inflows begin to decline 14 months after the Fed begins austerity measures.

Cash on the sidelines is often cited as a reason to be optimistic about future stock purchases. The logic is that all the money that goes into money market funds ends up being used there. And while Cox believes this argument could be on a list of reasons to be bullish on the stock market, “it’s not at the top.”

“There is a lot of opportunistic cash in the money markets that could disappear over time, but I think then people have overestimated the impact,” Cox said. “It’s not this chunk of money that flows in after every interest rate cut. It’s a little more complicated than that.”

So ultimately the money usually leaves the cash. It could either be bonds when the economic environment is weakening and investors want to get an attractive return before it declines. Or it could extend to stocks if the fundamental story surrounding the Fed’s rate-cutting cycle continues to scream for a soft landing.

If the prospect of not knowing which scenario will prevail scares you, there is still a reasonable way to earn almost 5% per year. And you don’t have to look beyond the growing pile of cash on the sidelines to see that many investors continue to choose this path.

Josh Schafer is a reporter for Yahoo Finance. Follow him on X @_joshschafer.

Click here for a detailed analysis of the latest stock market news and events affecting stock prices

Read the latest financial and business news from Yahoo Finance