Fed Policy Uncertainty! U.S. Money Market Funds Rush to Shorten Duration as $8 Trillion Shifts to Ultra-Short Assets

Faced with uncertainty over the Federal Reserve's policy trajectory, U.S. money market funds are undergoing a defensive shift known as 'duration shortening.'

According to Crane Data, while these funds manage over $8 trillion in assets, the weighted average maturity of their holdings has sharply contracted from 45 days to 40 days since mid-May—indicating that fund managers are rapidly reducing interest rate risk by reallocating capital toward ultra-short instruments.

This shift stems from recent market volatility. Soaring oil prices and hawkish comments from Fed officials initially led traders to price in a rate hike this month. However, subsequent softer inflation data has clouded the outlook once again.

Deborah Cunningham, Chief Investment Officer of Global Liquidity Markets at Federated Hermes, stated: 'We must preserve ample liquidity to seize better opportunities in the future, which requires shortening the weighted average maturity.'

This cautious stance is partly informed by lessons from early 2022, when the Fed launched an aggressive tightening cycle, leaving funds holding longer-duration assets in a vulnerable position.

Capital flows reveal a clear preference: repurchase agreements (repos) have become a core safe haven. In June, repo holdings surged by $36 billion, reaching a total of $1.89 trillion. DWS Group disclosed that nearly half of its investment portfolio is long-term allocated to repos.

Meanwhile, floating-rate notes have gained significant appeal. In June, holdings of U.S. Treasury floating-rate notes spiked to a record high of $523 billion, allowing funds to lock in high yields on three-month T-bills without extending duration.

Data from the Federal Home Loan Bank (FHLB) confirms this trend. Of the $180 billion in new debt issued by the institution this year, approximately $140 billion was in floating-rate notes.

Notably, despite the ongoing expansion in U.S. Treasury bill supply, money market funds reduced their holdings by nearly $105 billion last month.

Angelo Manolatos, a strategist at Wells Fargo, believes that given the lingering possibility of a September rate hike, fund managers have set a high bar. Excess cash is being prioritized into repos or floating-rate notes unless absolutely necessary. The market widely expects this 'shorten duration' trend to persist until inflationary pressures clearly subside.