Multi-Trillion-Dollar Question

Okay, we all watched this play out over the past few years. As cash yields rose, the money started flowing. And did it ever? Billions and trillions flowed into various cash vehicles from GICs, HISAs, and money market funds. A special thanks must be given to ‘inflation,’ which returned in a big way, resulting in the central bank responses of aggressively hiking overnight rates. The result: cash yields quickly became rather alluring.

In the U.S., money market balances increased from $4.5 to over $6 trillion over the past year and a half. Similar trends were also evident in Canada, adjusted for proportionate population/wealth. This leads to the big question: What will this money do as yields are now coming down? This is a multi-trillion-dollar question.

The Bank of Canada has started cutting, and the U.S. Fed appears to be on the cusp. Of course, the future path of rates remains uncertain, but the trajectory is not… it's down. Inflation has cooled, as has economic activity, so rate cuts are near a certainty. The speed and magnitude are unknown based on the data and expectations at this time. And that means those juicy cash yields will start to come down.

Even with expectations U.S. short-term cash rates are set to start coming down, the inflows into U.S. money market funds continue. More impressively, Canada has cut rates a few times already, and the flow of cash into Canadian vehicles has remained positive. The chart below is comparing apples and oranges between Canada and the U.S., so don’t pay attention to the dollar levels. The U.S. has ICI data on money market funds, while the Canadian chart shows the 30 largest cash vehicles. The takeaway from the chart is the trajectory of cash balances – the black lines, going up, stable or going down. So far still rising, albeit at a slower pace.

Line in the Sand

As yields available in cash vehicles come down, is there a line in the sand that will see inflows slow or even start to exit? As high yields entice the inflows, if they fall down to 4% or 3.5% or even 3.0%, will we start to see outflows? And where will that money go? We believe it depends on where the money originated, which could dictate its next destination.

Checking accounts & account sweeps – A sizeable amount of money from cash vehicles came from traditional checking or bank accounts. It was an easy decision as checking accounts paid much less than the yield available in cash vehicles. Many folks moved the excess checking account balance to an investment account to buy a cash product. Pick up that extra yield. This money is unlikely to move into more risky assets even as yields move lower. It simply isn’t risk capital. Maybe it stays, earnings less, or maybe some even move back to checking accounts if the spread in yield narrows enough.

Some of the money that went into cash vehicles was the small cash balance in portfolios. Perhaps the portfolio holds 1-3% cash to handle cash flow or expense requirements. When yields rose, it made sense to sweep these cash balances into a vehicle that would pay more. So even if yields fall, this money is unlikely to move as it is required for liquidity purposes.

Parking in cash – A portion of these huge cash vehicle balances has been parked because investors didn’t want to deploy into riskier investments. Fear of a market pullback, either equity or bond, combined with the attractive, safe yield in cash, caused many to allocate more to cash. If cash yields get too low this money could very well start looking for better returns or yields elsewhere.

This could result in sizeable bond inflows across the credit and maturity spectrum, as well as strong flows for dividend-paying companies. Many portfolios remain rather light on duration after the experience of 2022. Given that slowing economic growth is becoming a bigger risk than inflation, this may entice some of this money into longer maturities.

The dividend space has enjoyed a strong rebound over the past couple of months. The dividend factor has suffered over the past couple of years due to it being a higher-yield environment. There were simply many other choices to pick up yield, with less risk than dividend equities. But with cash yields falling, the attractiveness of dividends is starting to become much more compelling—although with more risk than cash, better taxation, and growth potential—and a lot more variables.

Telcos and pipelines yielding 6-7% might not be compelling enough compared to cash at 4.5%. But what about if cash yielded 4% or 3%? It is worth pointing out that over the past three months, the DJ Canadian Dividend Select index has returned 13.5% compared to 9.6% for the broader TSX, 2.9% for the S&P, and -1% for the Nasdaq—a clear reversal of the previous year.

Given that dollars don’t appear to be flowing out of cash vehicles just yet, this reversal has been more driven by falling bond yields lifting dividend stocks out of the basement. This could just be a short-term countertrend rally, or if yields have truly changed directions, this catchup may have a lot of room to run.

Final Thoughts

If you believe the cash allocation ‘call’ has nearly peaked, its reversal will likely see healthy flows into a number of areas of the market, including dividend-paying companies. Even if cash vehicles don’t see big outflows, a lack of inflows would mean more money goes back to normal bonds, dividends and other sources of income available in the market. More importantly, if this trend takes hold, it could have a long way to go, looking at how far previous flows went in other directions.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

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Sources: Charts are sourced to Bloomberg L. P.

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