In the first half of 2025, money market funds reached a record high of $7 trillion, showing investors' preference for safe, low-risk investment options over uncertain equity markets. Typically, when the Federal Reserve lowers its benchmark interest rate, investors switch from cash or cash-equivalent assets like money market funds back to equities. However, the current economic climate, shaped by President Donald Trump's tariffs and the ensuing market volatility, has complicated matters.
The Federal Reserve has temporarily stopped its rate cuts due to these uncertainties, making it easier for investors to adopt a 'wait and see' approach towards equities. Money market funds, which invest in low-risk short-term debt securities like Treasury bills, commercial paper and certificates of deposit, have been an attractive choice due to the higher rates they have been offering since late 2022 which stands around 4% as of May 2025.
Such rates are significantly higher than rates seen from 2007 through 2022. For instance, the 3-month Treasury Bill, commonly used to reflect money market rates, averaged 0.51% from 2010 through 2021, and only 0.02% as of May 2021. Even after Fed rate cuts, it stands around 4%, a substantial return for a risk-free investment.
Although the S&P 500 historically returns about 10% annually before accounting for inflation, clearly, many investors have opted for safety as opposed to higher returns with added risk. Contributing factors to this trend include the risk of a possible recession, tariff-driven inflation, potential long-term trade wars, and high equity valuations after a significant rise over the past two years. Just three days after Trump's 'Liberation Day tariffs' announcement, the S&P 500 was trading 15% lower than the closing price the day before the announcement.
Björn Jesch, former global chief investment officer of European asset manager DWS, notes that when market volatility and investor anxiety increase, money market funds gain popularity. Despite recent interest rate cuts, the rise in money market funds suggests investors are taking a cautious approach, preferring to preserve their capital rather than risk it for potentially higher returns. They seem to believe the current risks in the equity market outweigh the potential rewards.