Why Tariffs Spurred a Dash for Cash

Summary

Podcast Summary: "Why Tariffs Spurred a Dash for Cash"

Podcast Information:

• Title: Thoughts on the Market
• Host/Author: Morgan Stanley
• Episode: Why Tariffs Spurred a Dash for Cash
• Release Date: April 10, 2025

Introduction: Market Reaction to Tariffs

In the April 10, 2025 episode of Thoughts on the Market, Morgan Stanley's Chief Fixed Income Strategist, Vishi Tirupator, and Martin Tobias from the US Interest Rate Strategy Team delve into the recent volatility in the US stock market following President Trump's announcement to pause most tariffs for 90 days. The episode, recorded at 11:30 AM in New York, examines the immediate market reactions and the underlying stresses in the funding markets that influenced investor behavior.

Understanding Funding Markets: SOFR vs. Fed Funds Rate

The conversation begins with an essential primer on funding markets, focusing on two critical rates: the Secured Overnight Financing Rate (SOFR) and the effective Fed Funds Rate.

Martin Tobias explains:

“SOFR is the secured overnight financing rate and the effective Fed funds rate are both at the heart of funding markets... The effective Fed funds rate... is the main policy rate of the Federal Reserve... SOFR is a broad measure of the cost to borrow cash overnight, collateralized by treasury securities.”
[00:51]

Tobias highlights the disparity in market volumes, noting that while the effective Fed Funds market sees an average of $95 billion per day, SOFR encompasses a much broader transaction base with approximately $2.2 trillion per day.

Vishi Tirupator adds:

“So what you're telling me, Marty, is that the difference between these two rates really reflects how much liquidity stress is there or the expectations of the uncertainty of funding uncertainty that exists in the market. Is that fair?”
[01:46]

Tobias confirms this interpretation, explaining that the basis—the difference between SOFR and the Fed Funds Rate—serves as an indicator of liquidity stress and market uncertainty.

Recent Stress in Funding Markets

The discussion progresses to analyze the recent spike in funding stress. Tobias reveals that over the past three months, the Fed Funds basis has tightened to negative four basis points, a significant movement from the typical positive two basis points observed in more stable environments.

“...the three month SOFR Fed funds futures basis was positive. Two basis points... but this week... Fed funds tightened all the way to negative four basis points.”
[03:10]

This shift signifies increased investor demand for cash, leading to tighter funding conditions. Tobias attributes this to behaviors such as increased lending of securities in repo markets to raise cash and heightened selling or reduced lending of excess cash.

Comparison to Historical Funding Stresses

To provide context, Tobias compares the current funding conditions to past stress events:

“Funding conditions did indeed tighten this week, but the environment was far from true funding stress like in 2019 and certain periods in 2020... In 2019 when funding markets seized and the Fed had to intervene and inject liquidity three months... basis averaged negative 9 basis points... compared to negative 4 basis points during the peak macro uncertainty this week.”
[03:51]

This comparison underscores that while current conditions indicate stress, they are not as severe as previous instances where the Federal Reserve had to actively intervene.

Current State and Future Outlook

Tirupator assesses the present funding market:

“Funding conditions have tightened but I think the environment is far from true funding stress. Thus far the repricing has occurred because of a higher floor for funding rates and not a scarcity of reserves in the banking system.”
[04:25]

He suggests that the current repricing reflects a baseline increase in funding rates rather than a fundamental shortage of liquidity within the banking sector.

Impact on Bond Markets and Investor Behavior

The conversation shifts to the bond markets, where longer-term bonds experienced sell-offs due to their sensitivity to interest rate changes. Tirupator explains the investor shift towards ultra-short-term funds or cash to mitigate interest rate risk.

“...the longer the bonds the greater the interest rate sensitivity. So in periods of uncertainty... investors prefer to be in ultra short term funds or cash to minimize that interest rate sensitivity of their portfolios. So what we saw happening in some sense we can call it DASH for cash.”
[05:09]

This "dash for cash" reflects a broader trend of seeking safety amidst market volatility, leading to increased inflows into money market funds, as highlighted by both speakers.

Conclusion: Navigating Choppy Waters Ahead

Tirupator concludes by emphasizing the importance of understanding these funding dynamics for investors navigating the current market landscape:

“Your insights Marty, will be very helpful to clients as we navigate these choppy waters going forward.”
[05:44]

He reassures listeners that while the current funding stress is notable, it remains manageable compared to historical precedents, and ongoing demand for safety is expected to persist.

Notable Quotes:

• Martin Tobias [00:51]:
  “SOFR is the secured overnight financing rate and the effective Fed funds rate are both at the heart of funding markets...”

• Martin Tobias [03:10]:
  “...the three month SOFR Fed funds futures basis was positive. Two basis points... but this week... Fed funds tightened all the way to negative four basis points.”

• Vishi Tirupator [05:09]:
  “So what we saw happening in some sense we can call it DASH for cash.”

Key Takeaways:

1. Tariff Pause Impact: President Trump's decision to pause tariffs led to significant volatility in global stock markets, triggering a reassessment of funding conditions.
2. SOFR vs. Fed Funds Rate: The basis between SOFR and the effective Fed Funds Rate is a crucial indicator of liquidity stress and market uncertainty.
3. Funding Market Stress: Recent tightening in funding conditions indicates increased demand for liquidity, though not at levels seen in previous crises.
4. Investor Behavior: Uncertainty has driven investors to prefer ultra-short-term investments or cash, reducing exposure to interest rate-sensitive long-term bonds.
5. Outlook: While current conditions show stress, the market remains resilient, and the trend towards seeking safety is expected to continue.

This detailed analysis provides listeners with a comprehensive understanding of the interplay between tariff policies, funding market dynamics, and investor behavior, offering valuable insights for navigating the evolving economic landscape.

Transcript

[Vishi Tirupator]

Welcome to Thoughts on the Market. I am Vishi Tirupator, Morgan Stanley's Chief Fixed Income Strategist.

[Martin Tobias]

And I'm Martin Tobias from the US Interest Rate Strategy Team.

[Vishi Tirupator]

Yesterday, the US Stock market shot up quite dramatically after President Trump paused most tariffs for 90 days. But before that, there were some stresses in the funding markets. So today we will dig into what those stresses were and what transpired and what investors can expect going forward. It's Thursday, April 10th at 11:30am in New York. President Trump's Liberation Day tariff announcements led to a steep sell off in the global stock markets. Marty, before we dig into that, can you give us some funding markets 101? We hear a lot about terms like SOFR, effective fed funds rate, the spread between the two. What are these things and why should we care about this?

[Martin Tobias]

For starters, SOFR is the secured overnight financing rate and the effective Fed funds rate are both at the heart of funding markets. Let's start with what our listeners are most likely familiar with. The effective Fed funds rate. It's the main policy rate of the Federal Reserve. It's calculated as a volume weighted median of overnight unsecured loans in the Fed funds market. But volume in the fed funds market has only averaged 95 billion per day over the past year. SOFR is the most important reference rate for market participants. It's a broad measure of the cost to borrow cash overnight, collateralized by treasury securities. It's calculated as a volume weighted median that covers three segments of the repo market. Now, SOFR volumes have averaged 2.2 trillion per day over the past year.

[Vishi Tirupator]

So what you're telling me, Marty, is that the difference between these two rates really reflects how much liquidity stress is there or the expectations of the uncertainty of funding uncertainty that exists in the market. Is that fair?

[Martin Tobias]

That's correct. And to do this, investors look at futures contracts on Fed Funds and sofr. Now, Fed funds futures reflect market expectations for the Fed's policy rate. SOFR futures reflect market expectations for the Fed policy rate and market expectations for funding conditions. So the difference or basis between the two contracts isolates market expectations for funding conditions.

[Vishi Tirupator]

So this basis that you just described, what is the normal sense of this? How many basis points is the typical basis? Is it positive, is it negative?

[Martin Tobias]

In a normal environment over the past three years, when reserves were in abundance, the three month SOFR Fed funds futures basis was positive. Two basis points. This reflected SOFR to set two basis points below Fed funds on average over the next three months.

[Vishi Tirupator]

So what happened earlier this week is SOFR was sitting above the effective Fed.

[Martin Tobias]

Funds rate implying implying tighter funding conditions.

[Vishi Tirupator]

So Marty, what actually changed yesterday? How bad did it get and why did it get so bad?

[Martin Tobias]

So three months over, Fed funds tightened all the way to negative four basis points. And we think this was a reflection of investors increased demand for cash. Whether it was lending more securities outright in repo to raise cash or selling securities outright or even not lending excess cash in repo. This caused dealer balance sheets become more congested and contributed to higher SOFR rates.

[Vishi Tirupator]

So let's give some context to our listeners. This is clearly not the first time we've experienced stress in the funding markets in previous episodes. How far did it get? And give me some context.

[Martin Tobias]

Funding conditions did indeed tighten this week, but the environment was far from true funding stress like in 2019 and certain periods in 2020. Now in 2019 when funding markets seized and the Fed had to intervene and inject liquidity three months. So for fed funds basis averaged negative 9 basis points and that compares to negative 4 basis points during the peak macro uncertainty this week.

[Vishi Tirupator]

So Mari, what is your assessment of the state of the funding markets right now?

[Martin Tobias]

Right, funding conditions have tightened but I think the environment is far from true funding stress. Thus far the repricing has occurred because of a higher floor for funding rates and not a scarcity of reserves in the banking system.

[Vishi Tirupator]

So to summarize, the funding stress has been quite a bit earlier this week. Not as bad as the worst conditions we saw say in 2019 or during the peak Covid periods in 2020, but still pretty bad. And relative to how bad it got today, we are slightly better than what we were two days ago. Is that a fair description?

[Martin Tobias]

Yes. That's good. Now Vishy, what is your view on why the longer end of the bond.

[Vishi Tirupator]

Market sold off Longer end bond markets, as you know Marty, while safe from a credit risk perspective, do have interest rate sensitivity. So the longer the bonds the greater the interest rate sensitivity. So in periods of uncertainty such as the ones we are in now, investors prefer to be in ultra short term funds or cash to minimize that interest rate sensitivity of their portfolios. So what we saw happening in some sense we can call it DASH for cash. I think we both agree that this demand for safety will persist and we will continue to see inflows into money market funds which you cover in your research. So your insights Marty, will be very helpful to clients as we navigate these choppy waters going forward. Thanks for taking the time to talk to us.

[Martin Tobias]

Great speaking with you Vishvi, and thanks.

[Vishi Tirupator]

For listening if you enjoy thoughts on the market, please leave us a review wherever you get this podcast and share with a friend or colleague today.

[C]

The preceding content is informational only and based on information available when created. It is not an offer or solicitation, nor is it tax or legal advice. It does not consider your financial circumstances and objectives and may not be suitable for you.

[Vishi Tirupator]

Yesterday all my troubles were so far away. I believe in yesterday.