Short-term bonds offer wider yield advantage over cash
Key takeaways
- Cash yields have declined from their recent peak as the Fed lowered its target range for the fed funds rate.
- Short-term bond yields have moved higher as markets have priced in the possibility of a Fed rate hike rather than a cut and inflation expectations have risen.
- Short-term bonds may now offer investors a more-compelling balance: higher income potential than cash, though still with less interest-rate sensitivity than longer-term bonds.
Cash yields have pulled back in recent years
Cash yields have declined as the Federal Reserve lowered its target range for the federal funds rate. Cash-like investments — such as money market funds — hold Treasury bills and other instruments that are closely tied to the front end of the yield curve, so their yields tend to adjust quickly to changes in the Fed funds rate, shown in the chart below.
The chart shows that cash yields have fallen with Fed rate cuts.
The chart shows that cash yields have fallen with Fed rate cuts.
Cash yields appear likely to remain anchored near the near the fed funds rate, which we expect to hold steady over the near term. The Fed's preferred core Personal Consumption Expenditures (PCE) inflation measure has risen to 3.3% — well above the 2% target — limiting the case for additional rate cuts. At the same time, labor market remains resilient, giving policymakers room to focus on inflation.
Short-term bond yields have risen
While cash yields have moved lower, short-term bond yields have risen from recent lows. This reflects a shift in investor expectations: markets reflect that the Fed may need to keep rates higher for longer, and even potentially hike rates if inflation pressures persist. Inflation expectations — a key component of bond yields — have also contributed to higher yields across the yield curve. As a result, short-term bonds now offer wider yield advantage over cash, shown below.
The chart shows that yield advantage of short-term bonds over cash has widened. Short-term bond yield represented by the yield to worst of the Bloomberg 1-5 Year Government/Credit Index. Cash yield represented by the yield to worst of the Bloomberg U.S. Treasury Bellwethers 3-month Index.
The chart shows that yield advantage of short-term bonds over cash has widened. Short-term bond yield represented by the yield to worst of the Bloomberg 1-5 Year Government/Credit Index. Cash yield represented by the yield to worst of the Bloomberg U.S. Treasury Bellwethers 3-month Index.
Importantly, short-term bonds are not the same as cash. Their prices can fluctuate as interest rates move. However, because they have shorter maturities, they generally carry less interest-rate sensitivity than intermediate- and long-term bonds.
What this means for investors
Cash plays an important role in portfolios, providing funds for unexpected expenses, short-term savings goals and everyday spending. However, holding too much cash can pose the risk of lower long-term returns. After evaluating how much cash you need, consider gradually reinvesting excess cash.
Short-term fixed income investments — through bond funds, individual bonds or CDs — may offer a way to generate additional income while only modestly extending duration. Short-term bonds can provide a middle ground between the stability of cash and the higher interest-rate sensitivity of longer-term bonds.
Brian Therien
Brian Therien is a Senior Fixed Income Analyst on the Investment Strategy team. He analyzes fixed-income markets and products, and develops advice and guidance to help clients achieve their long-term financial goals.
Brian earned a bachelor’s degree in finance from the University of Illinois at Urbana–Champaign, graduating with honors. He received his MBA from the University of Chicago Booth School of Business.
Important information:
This content is intended as educational only and should not be interpreted as specific recommendations or investment advice. Investors should make investment decisions based on their unique investment objectives and financial situation. Opinions are as of the date of this report and subject to change.
Past performance of the markets is not a guarantee of future results.
Before investing in bonds, investors should understand the risks involved, including credit risk and market risk. Bond investments are also subject to interest rate risk such that when interest rates rise, the prices of bonds can decease, and the investor can lose principal value if the investment is sold prior to maturity.