Pause for effect

Market outlook

• The median federal funds rate forecast contained in the Summary of Economic Projections (SEP) released in conjunction with the Federal Open Market Committee (FOMC, the Committee or the Fed) meeting rose to 3.9% from the September 2024 projection of 3.4%, implying in our estimation a total of two cuts of 0.25% in 2025, down from the prior projection of four cuts of 0.25%.
• We believe the FOMC could move to adjust the federal funds target range moderately lower over time, although resilient employment data and sticky core inflation could prompt unchanged policy at one or more upcoming meetings over the next several months.
• Net T-bill supply will likely be constrained until the US debt limit is resolved, which may not take place until sometime this summer.

Q4 highlights

• The FOMC lowered the federal funds rate by 0.25% at both its November 7 and December 18 meetings, bringing the range to 4.25% to 4.50%. One member of the Committee dissented at the December meeting in favor of no change in the target range.
• An update to the statement¹ released in conjunction with the December meeting was made to add that “the extent and timing” of additional changes in the federal funds target range would be based on an assessment of “incoming data, the evolving outlook and the balance of risks.” The statement was otherwise unchanged.
• The median federal funds rate forecast contained in the Summary of Economic Projections (SEP)² released in conjunction with the December FOMC meeting for 2025 rose to 3.9% from the September 2024 projection of 3.4%, implying in our estimation a total of two cuts of 0.25% in 2025, down from the prior projection of four cuts of 0.25%.
• The updated SEP for 2025 reflected a stronger economic growth projection, a higher core inflation forecast, and a lower unemployment rate projection relative to September 2024.
• The timing of when core inflation is projected to fall to its 2.00% objective was pushed out to 2027 (from 2026 as of the September meeting).
• The FOMC also reduced the rate on the overnight reverse repurchase agreement (RRP) facility by 0.30% to set the rate equal to the bottom of the target range for the federal funds rate “to support the smooth functioning of the financial markets.”
• Despite contracting over $200 billion in September, net T-bill issuance rose $182.5 billion during the quarter.³ RRP utilization ranged between $98.4 billion, its lowest level since April 23, 2021, and $473.5 billion._⁴
• Assets across the US money market fund (MMF) industry increased $420.1 billion during the fourth quarter. Assets of government, prime and tax-exempt MMFs rose by $385.6 billion, $27.8 billion and 6.7 billion, respectively.⁵

Similar to the increase in government MMF assets across the industry, BlackRock government money market funds experienced net inflows during the fourth quarter.

Short-term Treasury rates fluctuated throughout the quarter, as markets prepared for the Federal Reserve to begin its rate cutting campaign. The 1-month Treasury bill saw the biggest decrease, ending the period down 53 basis points at 4.29%. Conversely, the 12-month tenor increased 15 basis points, finishing the period at 4.16%.⁶

At the start of the quarter, weighted average maturities (WAMs) in our government funds hovered near 30 days for repo-eligible funds and 41 days for non-repo funds. By the end of the quarter, these figures increased to 47 and 52 days, respectively, with funds positioning for the continuation of Federal Reserve rate cuts.

Purchases throughout the quarter were mostly comprised of 2-6 month T-bills at average yields of 4.41% to 4.58%.⁷

Year to date, markets received over $2.3 trillion of Treasury bill and coupon supply, with a heavy skew towards bills. Additional projected issuance is expected to be skewed towards coupons, as limitations are placed on bill issuance with the debt ceiling reinstatement on January 2, 2025.⁸

While eligible funds utilized the Fed RRP throughout the period, aggregate usage of the facility continued to decline, aside from quarter end when investors were seeking to house cash for year-end. We continue to see investors who favored the Fed RRP as an alternative to short-dated government securities are now rotating into new Treasury supply, and dealer repo rates remained more attractive, in our opinion. We expect this to continue following the Fed’s additional 5 basis point cut to the RRP rate, which further increases the attractiveness of dealer repo. We will continue to selectively add longer fixed rate duration to lock-in term rates as overall economic and inflation data has softened and created uncertainty regarding the future path of monetary policy.

Consistent with the increase in assets of prime MMFs across the industry, BlackRock prime money market funds experienced net inflows during the fourth quarter.

We believe investors exhibited demand for prime funds to take advantage of the incremental yield and diversification. At quarter-end, the spread between institutional government and prime MMF yields was 0.20%.⁹

Tier 1 Commercial Paper (CP) outstandings increased by $1.6 billion over the quarter to $375.2 billion. As expected, CP rates continued to reprice in line with expectations for the future path of monetary policy. Financial CP within our prime funds maturing in three months or less ended the quarter with an average yield of 4.84%.

Rates on money market deposit instruments, including time deposits and certificates of deposits, decreased throughout the quarter in line with rate cut expectations for the Federal Reserve. Unsecured overnight rates averaged 4.66% during the quarter, below the quarter high of 4.83%.¹⁰

Purchases during the period were primarily of certificate of deposits and time deposits, CP and overnight repo for eligible portfolios.

Although we favored a shorter-duration stance over the last several months to protect against interest rate volatility, we remain focused on adding exposures to highly rated longer tenor positions to add duration where appropriate to lock in attractive fixed-rate positions. At quarter end, our target WAM range was 40 to 45 days, and the funds had an average weekly liquidity of approximately 52%.¹¹

Given the shifting tone from the Federal Reserve, anticipated fiscal policies, increasing public wealth, and current inflation trend, we believe the risk of re-inflation is rising, and the likelihood for the Fed pausing early next year is increasing. This has helped support the yield curve as it remains flat to slightly inverted. We have selectively been adding floating rate exposure as we believe these instruments offer value in an environment where the Fed delivers less cuts than the markets anticipate. Additionally, we believe there is a need for heightened geopolitical caution, and we remain selective when adding credit risk.

Flows for tax-exempt money funds saw an uptick in the fourth quarter, ending with approximately $136 billion (from $129 billion in the third quarter) in industry assets.

Dealer variable rate demand note (VRDN) inventory ended the period at just $640 million, well below the rolling 12-month average of $4 billion. The Securities Industry and Financial Markets Association (SIFMA) Index, which represents the average yield on 7-day municipal floating-rate debt, began the quarter at 3.15%, fluctuated between 2.15% and 4.02%, and reset to 3.62% at quarter-end.

Total VRDNs outstanding ended the fourth quarter around $100.6 billion as tax-exempt money fund industry assets continued to surpass VRDN supply.

MuniCash remained positioned in the 5- to 6-day WAM range during the fourth quarter with high levels of daily and weekly liquidity, as the Fund intends to invest solely in securities that are considered weekly liquid assets as defined in Rule 2a-7 under the Investment Company Act of 1940, as amended (the “1940 Act”).

Though MuniCash intends to invest only in weekly liquidity assets, for broader market color, within the fixed-rate space, 1-year municipal bond yields and 1-year municipal note yields increased from 2.55% and 2.83% to 2.86% and 3.07%, respectively. 2024 municipal note issuance remained subdued compared to pre-pandemic issuance levels as municipal fundamentals remain supportive, however we expect it to continue to gradually move higher in 2025.

Looking ahead, we expect heavy January reinvestment cash will bring excess demand for VRDN securities, allowing dealers to reset VRDN yields much lower in the coming weeks. Low yields may push investors out of the space, which will then prompt dealers to reset VRDN yields higher by month-end.

Consistent with the theme across the ultra-short bond industry, the BlackRock Short Obligations Fund experienced net outflows throughout the fourth quarter.

Tier 1 Commercial Paper (CP) outstandings increased by $1.6 billion to $375.2 billion during the quarter. Additionally, Tier 2 CP outstandings increased by $2.5 billion to $95.0 billion at the end of December. Asset-Backed Commercial Paper (ABCP) outstandings increased by $16.3 billion to $367.7 billion.¹²

Yields in the Investment Grade (IG) space were slightly volatile throughout the quarter, with the yields on the JULI All Ex EM 1- to 3-year Index ranging between 4.25% and 4.93, as markets shifted their view on Fed policy.¹³

IG spreads continued their grind tighter throughout most of the quarter due to strong demand and light dealer balance sheets, however widened in the last half of December due to the added volatility from the December FOMC meeting and weaker liquidity, which is typically seen at year-end.

Fourth quarter IG issuance reached $237 billion. While this trended lower than previous quarters, following 2020, 2024 was the second highest issuance year on record, with ~$1.5 trillion issued throughout the year. Overall, investors continue to assess the Federal Reserve’s path of monetary policy and the outlook for economic growth.

Throughout the quarter, our focus was keeping the fund well positioned by focusing purchases on CP maturing between 1-week and 12-months at yields ranging from 4.56% to 5.30%. Other investments consisted of corporate bonds with maturities anywhere from 6-12-months to 2-years and beyond with yields ranging from 4.26% to 5.53%, 1 to 2-year treasury notes with a 4.22% yield, and 4-month to 2-year CDs with yields ranging from 4.45% to 5.33%.¹⁴

Market expectations of more than one rate cut in 2025 are slim but continue to remain contingent on inflation and employment data. In IG, with growing uncertainties in the United States and abroad, we remain selective when adding credit risk.