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What do neutral rates mean for cash management?

Neutral rates are defined as the level that neither encourages nor deters overall economy activity in a particular country.

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2020-2025 OVERVIEW
Over the past five years, central bank policy shifts have reshaped the cash landscape - and money market funds (MMFs) have been at the center of it all. During the Covid pandemic, MMFs provided stability when markets were under stress. MMFs saw increased utilization as part of cash management strategies during the period of rising interest rates, with policy rates peaking above 5% in the US, around 4% in the Eurozone and exceeding 5% in the UK1. This drove record inflows, pushing industry AUM beyond $7 trillion and cementing their position as a strategic cash solution. Even in periods of declining interest rates, we believe MMFs remain essential for liquidity management and capital preservation, offering flexibility and innovation through enhanced resilience and regulatory framework. In a world of uncertainty, MMFs seek to deliver liquidity, stability and yield - in that order.

Predicting the medium to long‑term path of interest rates, particularly during periods of geopolitical turmoil and uncertainty around global trade, remains a significant challenge. What liquidity considerations face investors as they manage cash exposures during a period of neutral rates?

What are neutral rates?

After raising rates aggressively in 2022–2023 to tackle post‑pandemic inflation, major central banks are in a gradual normalisation phase. Policy rates in the US, UK and Eurozone have moved down from their recent peaks but remain positive in real terms and close to, or slightly above, most estimates of “neutral”.
In the US, the Federal Reserve (Fed) has begun easing from its 2023 peak of 5.25%–5.50%, bringing the federal funds target range down to 3.50%–3.75% by late 2025. In the euro area, the European Central Bank (ECB) has reduced its deposit facility rate to 2.0%, after cumulative cuts of two percentage points since mid‑2024. In the UK, the Bank of England (BoE) has lowered Bank Rate from a 16‑year high of 5.25% to 3.75%.

At these levels, we believe policy is still mildly restrictive in many models, but far from the extremes seen during the zero‑rate era or the 2022–2023 tightening peak. Estimates of the nominal neutral rate cluster in a range of roughly 2.0%–4.0% across major developed economies, implying that current settings are closer to the “steady‑state” regime that many investors associate with neutral rates.​

However, the path back to neutral has not been smooth. Differences in growth, inflation and fiscal policy across regions, alongside persistent geopolitical tensions and renewed uncertainty around global trade, have produced asynchronous rate cycles. For example, stickier inflation has resulted in a more cautious cutting cycle by the Fed and BoE, while softer growth in the Eurozone has justified faster cuts by the ECB.

Cash management strategies when rates are neutral

The prospect of interest rates finding a new equilibrium in the range of 2.0% to 4.0% means that investors remain under pressure to carefully manage their cash holdings.

For investors with exposure to US dollars, sterling and euros, working with a global cash manager that can continuously monitor central bank and public policy, yield curves and money‑market conditions across regions can help manage the risks associated with interest‑rate moves and other significant market developments.

By holding a combination of highly liquid assets, ranging from government debt and repurchase agreements (repo) to commercial paper and certificates of deposit, can help mitigate concentration risk.

In an environment of economic uncertainty, maintaining flexibility through diversified exposures and duration positioning is essential to navigating short-term rate fluctuations.

Investors are likely to be subject to rules that oblige them to maintain minimum liquidity levels. Investors may benefit from the pooled liquidity provided by a MMF which generally offers same or next day access to invested funds.

While longer-dated instruments seek yield enhancement, they also introduce greater duration risk. Investors may consider balancing return objectives with capital preservation and liquidity needs. The active management of MMFs may help them to be dynamic and react to changes in markets. This can lead to the potential for enhanced yield.

How money market funds may meet investor needs

MMFs are sometimes used in institutional liquidity strategies, aiming for a blend of capital preservation, daily liquidity and yield potential.

These funds invest in a diversified pool of high-rated, short-term instruments, including but not limited to sovereign and corporate debt, repos and time deposits, while adhering regulatory and credit standards depending on the type of MMF:

  • Government Money Market Funds may be consideration for operational cash, most provide same day settlement and a stable Net Asset Value, depending on the structure you are investing in.
  • Prime Money Market Funds offer the potential for a total return, as they purchase a broad universe of securities and utilize a floating net asset value, while still maintaining high levels of liquidity to accommodate same day settlement. Investments can include government securities, and securities issued banks, corporations and other non-government entities.

The use of MMFs can be tailored to each investor’s specific requirements. This means a different approach could be a consideration for different cash segments, such as operational, core and strategic cash balances. Investors may consider their investment horizon and appetite for risk: ongoing uncertainty around short-term interest-rate movements means that moving into longer-dated investment strategies can lead to considerably higher levels of risk, as well as potentially higher returns.