Fed Opens Floodgates as Investors Flee to Cash

(Photo: Susana Gonzalez/Bloomberg)

Cash is king in a market that has now a suffered declines of more than 30% in major stock market indexes since mid-February, sloppy trading in investment-grade bond funds that were supposed to offset the risks of stocks and 10-year Treasuries yielding about 70% more than they were in early March.

Even gold, which, along with Treasuries often acts as flight-to-safety assets, has lost 7.5% of its value, from recent highs near $1,675 an ounce reached in late February and again in early March.

The Federal Reserve is trying hard to support financial markets and the economy. After announcing $700 billion in asset purchases last week, on Monday morning the Fed opened the spigots. It removed any limits on that revived quantitative easing program, saying it would continue to purchase Treasuries and MBS in “amounts needed to support smooth market functioning and effective transmission of monetary policy” to support financial conditions and the economy.

The Fed also announced Monday it would be buying investment-grade securities in primary and secondary markets and through exchange-traded funds — something it has never done before. In addition, the Fed said it would initiate lending programs for small businesses, consumers and large employers and a term asset-backed loan facility (TALF), which it had used during the financial crisis.

U.S. stocks pared lows after the Fed announcement, but the S&P 500 and Dow Jones Industrial Average were down more than 4% by late morning. The 10-year Treasury yield was 74 basis points, lower than Friday’s close just about 1%, indicating continued concerns about an economic recession or worse.

Investors have been reacting to the continued bad economic and market news, favoring cash over all other assets. According to fund flows report from Bank of America, there have been record outflows from investment-grade, TIPS, mortgage-backed and municipal bond funds in the week ended March 18. A total $108.9 billion left bond funds, roughly half ($55.3 billion) from investment-grade bond funds.

Equity funds experienced far fewer withdrawals, $20.7 billion, but that total included a record one-day outflow on the previous Friday, of $20.2 billion. Gold funds saw outflows of $2.5 billion. Almost $96 billion flowed into cash or money market funds.

Clearly money market funds have become the preferred flight-to-safety asset for investors, many of whom are reportedly selling bonds to raise cash rather than equities, which have fallen even more in value. 

One dramatic measure of the growing popularity of money market funds: three- and six-month Treasury bill rates fell below zero on Friday, to -3 basis points and -2 basis points, respectively.

Demand is so strong for cash that some institutional investors are willing to pay a small price to own it, says Kathy Jones, chief fixed income strategist for the Schwab Center for Financial Research. “There is no place to hide other than cash, which is considered safe with low volatility.” 

Jones is not suggesting, however, that investors unload more bonds now — “we’ve gone a long way to price in a lot of bad things” — but suggests they start looking around for securities to purchase if they have a long time horizon and have some confidence in the creditworthiness of an issuer.