Q1 2025 Cash Outlook Dawn of a New Future

From the US policy rate path to Fed’s tapering of quantitative tightening, and maybe even the dawn of a new future for cash investing in asset tokenization and stablecoins—2025 looks poised to be a very happening year for cash investors.

Looking back, 2024 feels like a whirlwind—another year that seemed to pass in the blink of an eye. It was marked by persistent questions early in the year about when cash would flow out of money market funds (MMFs) and be redeployed into the economy.

My answer then was the same as it is now, as we begin 2025: it depends on the availability of compelling opportunities. Investors need assets of genuine value—not ones at new highs (equities) or tight spreads (credit). Alternatively, economic pressures such as declining business revenues or personal cash flow constraints may necessitate the drawdown of these funds.

MMF balances ended 2023 at $5.87 trillion and grew by approximately 15% over 2024, reaching $6.75 trillion as of 18 December 2024 (source: Investment Company Institute [ICI]). This remarkable growth underscores two significant factors: the wealth effect is massive, and people and entities are conservatively sitting on more cash in case of need or opportunity. Over the past five years, MMF balances have surged by an astonishing 87%.

Government MMFs were the primary beneficiaries of these balance increases, with institutional and retail categories growing by 15%. Retail prime MMFs also saw healthy growth, rising by 12% to $1 trillion. Meanwhile, institutional prime MMFs faced substantial challenges, with AuM declining by 18%, though the drop was less severe than some had anticipated.

Institutional prime MMFs currently hold ~$218 billion in assets, far above the $122 billion low seen after the 2016 MMF reforms, but below the 2020 peak of $320 billion. New Securities and Exchange Commission (SEC) regulations will likely limit institutional investors returning to this sector and may lead them to seek out similar returns in other offerings, like local government investment pools or ultra-short-term investment funds.

The yield difference between institutional prime and government MMFs is a crucial variable that drives flows. Our estimates suggest this spread will range between 5–15 bp, contingent on the credit cycle and broader market dynamics. During risk-off events—such as March 2020 or the 2023 mini-banking crisis—this spread could widen significantly.

As of now, the average yield differential stands at 12 bp. However, investors in institutional prime MMFs must carefully evaluate the potential impact of liquidity fees, as these could erode carried interest if applied. Historical data illustrates key points where liquidity fees might have been warranted, such as March 2020, when the spread between three-month commercial paper (CP) and T-Bills widened dramatically. Such events can also provide opportunities for other investors that are not subject to SEC rules.

Still More Uncertainty in US Policy Rate Path

The 2024 policy rate path was anything but clear, with the Fed revising its Summary of Economic Projections and the Fed Funds Futures market gyrating wildly. For example, the rolling 10th Fed Funds Futures contract started the year at ~4%, climbed to ~5% in April, dropped near ~3% by September, and ended 2024 again around 4%. This volatility reflects the difficulty of forecasting market rates in such transitional and uncertain times.

The Fed’s Dot Plot has also faced criticism for inconsistency, though this is largely a reflection of a complex and ever-evolving economic landscape. Policymaking is inherently challenging, particularly amid efforts to anticipate the trajectory of an economy navigating post-pandemic adjustments and vast political uncertainty.

The New Neutral

For 2025, consensus suggests two or three 25 bp rate cuts, with the March, June, and September meetings having the highest probabilities for policy moves according to the markets. While the exact cadence remains uncertain, the next policy rate move is expected to be downward. At this point, there is no reason to believe the Fed will pause on cutting its policy rate, nor do we believe it will be given reason to raise policy rates. With that said, we can expect that “neutral” rate to be higher than originally forecasted at the end of 2023. Fed Funds policy rate between 3.50% and 4.00% by the end of this year is not unreasonable.

The journey toward neutral rates will be slower in the US, where fiscal stimulus and pro-business deregulation are poised to heat up the economy. The US economy appears more resilient than most developed economies – Europe, Canada and the UK have already begun easing monetary policy and appear eager to cut further to avoid a hard economic landing.

The US will not be in such a hurry due to challenges that may arise from the incoming administration’s policies surrounding tariffs and immigration, as they could complicate economic dynamics. Tariffs may create price instability if used as negotiating tools, while restrictive immigration policies could exacerbate labor shortages and constrain growth. Balancing pro-business initiatives with these challenges will be critical.

Quantitative Tightening and Debt Dynamics

Quantitative tightening (QT) will remain a focal point in 2025. As the Fed continues to allow assets to roll off its balance sheet, bank reserves should eventually begin their decline as they did in 2018-19. While QT’s impact has been limited so far, growing strains are emerging, such as increased primary dealer balance sheets and rising Secured Overnight Financing Rate (SOFR) rates.

When reverse repo (RRP) balances reach zero and bank reserves begin to decline, the upward pressure on SOFR rates is likely to intensify, prompting discussions about ending QT and establishing a level of reserves to maintain order in the money markets. The Fed will aim to ensure an orderly transition to a smaller balance sheet, avoiding disruptions like those seen in September 2019.

US Debt Ceiling Fiasco—Again!

The US debt ceiling will also loom large in H1 2025. Escalating debt levels highlight the lack of political will to address entitlement programs or raise taxes. For MMF investors, the silver lining is the abundant supply of Treasury securities, which will likely persist in the near term.

Stablecoins and the Tipping Point

If you’re a fan of Malcolm Gladwell, you’ve likely come across his latest book, Revenge of the Tipping Point. True to his signature style, Gladwell explores patterns and trends in culture and society, analyzing how they evolve from niche phenomena into mainstream movements. The stories and examples in the book are as engaging as ever, but for now, let’s focus on one trend that is reshaping the financial system: the evolution of “cash.”

How do individuals and entities move cash efficiently across borders and through the banking system? Traditionally, this process has been expensive, slow and complex. But is that starting to change? Enter stablecoins, such as Tether and USDC, which are gaining traction as transformative tools in global finance. According to CoinMarketCap.com, Tether’s market cap has surpassed $138 billion, underpinned by the increasingly robust infrastructure.

With a new US administration seemingly open to innovation in digital finance, stablecoins could see broader adoption and utility. This raises an intriguing question: Could stablecoins expand the global use of the US dollar?

The dollar already dominates international trade and finance, with over 60 countries pegging their currencies to it. If stablecoins gain further acceptance, could they disengage the traditional banking system from the payment process?

Some asset management firms are exploring the potential of tokenizing MMFs, hinting at a future where digital assets blend seamlessly with traditional financial products. While this movement is gradual, it prompts the question: When will we reach the tipping point?

The history of money market funds (MMFs) offers valuable perspective. Introduced in the early 1970s, MMFs were initially a niche retail product, offering higher interest rates than bank accounts and the convenience of check-writing from mutual fund accounts. Their rise was not without challenges; the SEC implemented Rule 2a-7 in 1983 to address regulatory issues. Growth remained modest through the 1980s, but by the 1990s, MMFs hit their tipping point.

At the start of the decade, MMF assets under management stood at just under $400 billion, according to the Investment Company Institute. By the decade’s end, that figure had soared to over $1.6 trillion—more than a fourfold increase. In contrast, commercial bank deposits grew at a slower pace, from ~$2.2 trillion to ~$3.4 trillion over the same period. This explosive growth marked MMFs as a transformative financial tool with widespread benefits.

The stablecoin market is still in its early stages, with significant learning and development required before it integrates fully into the broader financial framework. However, if stablecoins can deliver on their promise of faster, safer and more cost-effective transactions, they may very well catalyze the next tipping point in global finance.

The parallels between the rise of MMFs and the potential of stablecoins are striking. History suggests that change often starts slowly, gaining momentum until it reaches a critical mass. Are we on the cusp of a similar revolution? Only time will tell.