Market spotlight: Money market funds and recent rate cuts

Considered safe havens during the credit crisis and falling equities markets, money market accounts are now providing little to no profit for investors. These accounts typically invest in short-term debt, which rise and fall with Federal Reserve interest rate changes.

With the Fed cutting rates from 3.5 percent in late January to 2 percent Wednesday, rates on money market accounts have dropped from between 4 percent and 4.5 percent to close to 2 percent, Matt Snowling, an analyst with Friedman, Billings, Ramsey said.

The current rates now fall below inflation rates, meaning on a real-dollar investment, customers are losing cash in money market accounts, Snowling said. That has triggered the beginning of a move back to higher-yielding but riskier investments, such as fixed income and equities.

"Historically when there is a negative real rate of return, money flows out and into equities, real estate and commodities," Snowling said. If interest rates remain low and inflation remains high, the outflows of cash from money markets should continue to grow, he added.

As equities markets tumbled during the first quarter and credit markets remained unstable, customers poured cash into money market accounts. Inflows into money market accounts increased each week in the first 12 weeks of this year, according to Money Fund Report. During those weeks, total cash in money market accounts rose 10 percent to a peak of $3.46 trillion, according to Money Fund Report.

In the first three months of the year as cash was funneled into money market accounts, the Dow Jones Industrials average fell nearly 8 percent, while the Standard & Poor's 500 index tumbled 10 percent.

Three of the last five weeks through the week ended April 29 have seen a decline in total cash in money market accounts; it's now 1.2 percent lower than it was when it peaked earlier in the year, falling to $3.416 trillion, according to Money Fund Report.

Since cash started flowing out at the beginning of the second quarter, the Dow Jones Industrials average has increased 6 percent, while the S&P 500 has gained about 7 percent.

Which companies are expected to profit from the outflows is still up in the air, Snowling said, as it hinges on what types of products and markets customers prefer to enter.

Regardless of product type, if investment managers can keep the business within their company, profitability for investment managers will improve, Snowling said.

Generally, fees gained on money market accounts are much smaller than fees on fixed income or equity products, Snowling said. The higher margin products would help profitability, he said.