Wall Street Eyes $6 Trillion Cash Tsunami Sparked by Fed Pivot

A roughly $6 trillion hoard of cash sitting on the sidelines is one significant element that investors keep an eye on, watching whether markets can continue their wild run.

Rising rates have attracted money to money markets and other short-term securities, as many investors opted to park their money in these extremely secure investments and earn income while they waited to see how the Federal Reserve would handle rising inflation.

Investors React to Fed's Dovish Shift by Realigning Portfolios

On December 6, the total assets held in money market funds reached a record $5.9 trillion, as reported by the Investment Company Institute.

That calculation may have been upset by the Fed's unexpected dovish turn on Wednesday: if borrowing costs decline in 2024, yields will probably follow suit. This may cause some investors to pour money into riskier assets like equities, while others would hurry to lock in bond rates on longer terms.

According to BlackRock statistics dating back to 1995, cash has returned an average of 4.5% in the year after the Fed's final rate rise of a cycle, while U.S. stocks have increased by 24.3% and investment grade debt by 13.6%.

The market's recent behavior suggests that the rush to realign portfolios may have already begun. Since Wednesday's Fed meeting, benchmark 10-year Treasury yields-which are inversely correlated with bond prices-have dropped by around 24 basis points to 3.9153%, the lowest level since late July.

The S&P 500 is now less than 2% behind a record high, having gained 1.6% since the Fed's announcement on Wednesday. This year, the index has risen about 23 percent.

Assessing Accessible "Dry Powder" and Investor Risk Appetite

It's possible that not all of the money in money market funds is accessible as "dry powder" for bond and equity investments. According to Peter Crane, head of Crane Data, a company that analyzes money market funds, some of it is held by organizations who may otherwise have that money in bank accounts and is required for cash needs.

Additionally, historically speaking, the majority of cash in money markets tends to stay there even as interest rates decline, according to LPL Financial Chief Technical Strategist Adam Turnquist.

Furthermore, even while money market assets are at all-time highs, their size in relation to the S&P 500 is lower than it was at previous peaks.

The total assets held by money market funds as a proportion of market capitalization are now at 15.5%, which is significantly below the record high of 64% reached in 2009 during the global financial crisis and in line with the long-term median.

But as of right now, it's clear what kind of risk investors are willing to take. In the options market, for instance, traders are rejecting protection against a short-term stock market decline despite the historical attractiveness of the cost of these hedges. This month saw a return to pre-pandemic lows for the Cboe Volatility Index, which measures demand for protection against market fluctuations.

Indeed, some investors are concerned that markets have recovered too rapidly following the significant increase in shares from their October lows.

But the quick increases in stocks and equities over the last six weeks "makes you a little concerned about where the upside is from here for the markets overall," he added.