The recent flood of cash from bank deposits to money-market vehicles has sharpened investors’ focus on just how much more nimble those funds are in passing on interest-rate changes by the Federal Reserve.

Over the past two decades, money funds have passed on around 88% of changes in central bank interest rates, compared with just 26% for rates on retail cash deposits — more than three times the amount — according to an blog post from the Federal Reserve Bank of New York. And that dynamic, combined with lag effects, means that there’s scope for money funds to keep ballooning in size.

Updating a study that was originally conducted in 2019, the New York Fed researchers conclude that money-market vehicles have continued to respond with greater alacrity during the most recent cycle of central bank interest-rate increases. As a result, they posit that the growth of the US money-market mutual fund industry is set to continue in the wake of the hikes implemented by the Fed during the past year.

“During the current tightening cycle, MMF yields have increased by 4.13 percentage points, in line with our previous estimate of the beta on MMF shares between 2002 and 2020,” a team of researchers, including Gara Afonos, wrote in a post Monday on the New York Fed’s Liberty Street Economics blog. “In contrast, deposit rates have remained flat.”

They noted that between April 2022 and January 2023 — which encompassed much of the Fed tightening — money fund assets increased to $4.62 trilllion from $4.31 trillion in April 2022. The researchers judged that to be “relatively small” given that the Fed had increased its benchmark target by 4.25 percentage points by the end of January to a range of 4.25%-4.50%

That was “likely due to a lag with which monetary policy affects investor flows in MMFs,” the NY Fed staffers said in the blog. “The recent monetary policy tightening, in fact, could lead to a further expansion of the MMF industry in the near future.”

The amount of cash parked in money funds has grown further since then following additional rate increases by the Fed — its benchmark range is now 4.75%-5.00% — and the banking turmoil that surrounded the collapse of Silicon Valley Bank and other lenders.

With fears around the prospects for smaller institutions prompting many to pull cash from bank accounts, total money fund assets have now ballooned to $5.2 trillion, according to data from the Investment Company Institute. That includes more than $300 billion of net new funds in just three weeks.

Of course the speed at which money fund companies respond relative to banks to Fed rate increases is mirrored in reverse during periods of monetary easing.

That is something that traders are pricing in over the horizon, but before then the market suggests there will probably be at least one more hike to come — at the Fed’s next meeting. Current pricing in swap markets shows a quarter-point hike in May is seen as more likely than not, while pointing to more than half a point of cuts by the end of 2023.

“The gap between the deposit and MMF betas increases the appeal of MMF shares relative to bank deposits when the Federal Reserve tightens its monetary policy and decreases their appeal when the Federal Reserve cuts rates,” the researchers said in the blog. “As a result, the size of the MMF industry tracks the monetary policy cycle, albeit with a lag.“

This article was provided by Bloomberg News.