There’s a major flaw in the stock market’s most bullish thesis

• Money market funds won’t save the stock market from a painful decline, Bank of America says.

• A 25-basis point Fed rate cut won’t change the behavior of savers, according to the bank.

• If cash does leave money market funds, it won’t flow to stocks.

The $6 trillion in money market funds will not save the stock market from a painful decline.

A common component of the bullish thesis for stocks over the past year is that trillions of dollars of sidelined cash are set to flood the stock market once the Federal Reserve cuts interest rates, putting downward pressure on the juicy, risk-free 5% yield most money market funds offer.

But Bank of America says not so fast, offering two structural reasons money market funds won’t be the catalyst for a continued bull rally many investors expect.

First, a measly 25-basis point interest rate cut from the Fed likely won’t change the behavior of savers, as a cash yield of closer to 4% would still be a lot better than near-0% rates offered from 2009 through 2021.

An interest rate decline of hundreds of basis points wouldn’t do the trick either, according to the bank.

“Historically, MMF [Money Market Fund] AUM growth y/y is typically positive unless front-end rates <2%,” Bank of America rates strategist Mark Cabana said in a note on Thursday.

According to Cabana, for money market funds to see negative outflows, the Fed would need to cut rates by at least 300 basis points, and that’s not scheduled to happen anytime soon.

“Fed cuts will see MMF inflows slow but remain positive unless rates near zero,” Cabana said.

The December 2025 target for the federal funds rate is just above 3%, according to the CME FedWatch Tool.

The second issue is that even if the Fed were to substantially cut interest rates and spark a wave of redemptions from money market funds, that cash probably wouldn’t flow into the stock market.

According to Cabana, bonds would be the big beneficiary instead because money market funds compete mainly with checking accounts that offer near 0% yields rather than stocks.

“If MMF outflows happen cash likely to move into higher yielding fixed income, not equities. MMF to equities = bridge too far,” Cabana said.

Stock market bulls should ultimately retire the idea that trillions of dollars of money market funds will help buoy stock prices, the analysts said.

“MMF cash should remain sidelined from a risk taking perspective,” Cabana concluded.

Read the original article on Business Insider