For the first time in almost 15 years, cash is no longer ‘trash’ – that is paying 0% – 1% yields. But for investors enjoying 5% yields on money-market funds, a Fed interest-rate cut is looming — most expecting the first decrease to come at the September meeting.
There’s about $6 trillion sitting in money market funds, which have been yielding over 5%.
We may be at a turning point. Market watchers have been holding their breath for a Federal Reserve interest-rate cut since the beginning of 2024. Investors have a historical tendency to linger in money-market funds and similar instruments much longer than they should. As soon as the Fed begins to cut rates, institutional investors may extend the yield curve for more price appreciation, while individual investors tend to do so a year to 18 months after the rate-cutting cycle begins.
Investors aren’t necessarily as quick as they should be. The market currently expects the Fed to cut benchmark rates six times through 2025. Assuming they cut 25 basis points each time for a total of 150 basis points. Bonds go up in price when interest rates drop. By contrast, the yield simply drops on a money-market fund—there is no price appreciation.
For investors with slightly more risk appetite, look to one or two rungs up the bond risk ladder—to short-dated investment credit or front-end two- to three-year Treasuries—to lock in yields today at around 4.7%. That may not be as good as a 5% money-market fund yield, but a percentage-point rally in rates will also contribute 1% to 2% in capital appreciation over that coupon rate, since falling yields also mean more price appreciation for bonds, which investors can’t achieve with cash. Investors should ‘skate to where the puck’s going, not to where the puck has been’.
‘Playing it safe’ doesn’t necessarily mean simply owning money-market funds and Treasury bills. The typical money-market fund earned around 5.2% in 2023. Compare that with an ultrashort bond fund, whose total return was over 6% in 2023 An ultrashort bond strategy—which invests in zero- to one-year high-quality corporate bonds, asset backed securities and the like—can achieve a higher return from a touch more interest-rate exposure, price appreciation and spread income.
It’s a slightly more active cash management strategy that allows for price appreciation—that you don’t get with a money-market fund—as the Fed moves to lower rates.
The Fed will likely cut rates further, later this year. Investors can prepare for that, considering moving out of cash and money market strategies to a bit longer term to create price appreciation.
Investors have been especially keen on money markets since they broke above 5% in August 2023. Though they have fallen to $6.098 trillion after rising for the eight previous weeks, money market mutual fund assets are still up by $212 billion, or 4.5%, in 2024 through June 18, according to the Investment Company Institute.
When compared with yields offered by many bank savings and checking accounts—which are below 1%—money-market funds are a no-brainer. Indeed, much of the inflows into money-market funds over the past year have come from consumers dissatisfied with the paltry rates on their bank accounts.
Many investors can’t help comparing the guaranteed rates on money-market funds to bond funds in their portfolios and wonder why they own any bond funds at all. This is shortsighted because when rates drop, the portfolio’s fixed-income investments will appreciate given the longer duration and maturities.
Investors may not want to hear it. It has been a miserable time to own bonds; the iShares Core U.S. Aggregate Bond ETF is flat so far this year and down 3% over the past three years.
But with the changing market and fed rate cuts looming, it may be time to take a fresh look at bond funds.