Earlier this week, I noted that money market funds are throwing off an estimated $22 billion in monthly interest income.
Notwithstanding an anomalous outflow over the latest weekly reporting period, savers of all shapes and sizes funneled cash into money funds at an unprecedented rate in 2023. Money fund AUM is up more than $1 trillion over 12 months. That cash pile is earning in excess of 5%, risk free.
For households, that’s extra income. It’s a windfall. It you refinanced your mortgage in 2020 or 2021, you got a two- or three-handle, and you’re now earning 5% on your savings.
There’s a similar dynamic on the corporate side. Companies which termed out courtesy of wide-open debt markets in 2020 and 2021 (after the Fed kicked the door open to massive issuance with an unprecedented backstop for corporate bonds) are now in an amusingly fortuitous position: They’re beneficiaries of higher rates. After the borrowing binge, they were sitting on an enormous cash pile, which they tapped to fund operations in 2022, thereby shielding themselves from rising debt costs. Leftover cash earned increasingly higher rates as the Fed hiked.
Of course, not everyone benefits equally from the dynamic sketched above. As discussed here on too many occasions to count, cash-rich big-caps are insulated for longer while small-caps are more vulnerable (small-caps have a very steep maturity wall, the S&P 500 not so much).
As I put it on September 11, “rising rates amplify the equity market’s haves/have-nots divide.”
Nomura’s Jack Hammond echoed that this week. “The economy is comprised of haves and have-nots. The haves are large corporations that refi’d a gargantuan amount of debt at historically low levels of yields and the top X% of the population that has savings that are now returning 5+% vs their mortgage at 3-%,” he wrote. “The have-nots are small businesses facing higher floating rate borrowing costs and individuals with no savings who are seeing their monthly food/rent/clothing/energy costs jump with inflation.”
Hammond elaborated and put the discussion in the context of the term premium and the distinction between the long run neutral rate (which officials are reluctant to concede is now higher) and shorter-term neutral, which Jerome Powell has repeatedly admitted might’ve increased (he said as much again during Thursday’s chat with David Westin at the Economic Club Of New York).
“If 2021 was the year of the refi, and the average length of corporate issuance is five years, there is still some runway until we hit the refunding cliff,” Hammond wrote. “If you converted to a 5/1 ARM the same year, you have the same window of time to earn your money fund-mortgage spread income.”
This is absolutely critical, I think, and it speaks eloquently to the discussion from “Are We There Yet? (No)” published on October 16. That linked article is the layman’s version. Hammond offered a more nuanced version. To wit (the quote is Hammond’s, I inserted the chart for illustrative purposes):
Powell’s rolling neutral rates vs constant long term dot becomes much more of a tangible concept when viewed in the above context. We have a few more years where the neutral rate will remain on the higher side given the structure of corporate America and the population with savings. This is why pushing term premium higher is critical. Higher term premium means your 5y5y refunding rate makes your expected refinancing costs scary.
When 5y5y was 200bps below the Fed rate, large companies and folks with resetting mortgages were not fearful of future cash flow problems. As 5y5y climbs and suggests your refinance might actually happen at current rate levels, your projections of future cash flows becomes more concerning. This impacts what you are willing to spend today.
He exhorted market participants to “go read Esther George,” where that meant remarks prepared for the Economic Club of Indiana in January of 2022.
“As we purchased assets, our goal was in part to artificially depress term premia, pushing down long run rates and supporting economic activity,” she said, prior to the onset of the Fed’s hiking cycle. “In normalizing our balance sheet, we should aim to eliminate this distortion.”
