July 17, 2023
Yields on cash investments are at their highest levels in more than a decade thanks to rising interest rates. But with the Federal Reserve slowing the pace of rate increases, investors may want to reevaluate their portfolio’s allocation to cash in favor of potentially better opportunities in fixed income.
Cash yields may remain high into 2024
Following a bold pace of hikes to tame inflation, the Fed slowed the pace of rate increases in June, leaving its overnight policy range at 5.00% to 5.25%.
While inflation may be cooling down, the jobs market isn’t. Job conditions have rarely been so strong — with unemployment at 3.7% in May and nearly two jobs for every person unemployed and looking for work. And recent comments from Fed officials highlight the need to lower inflation by increasing slack in tight labor markets. As such, future rate hikes are not off the table, just yet.
It will likely take several quarters for the Fed’s policy efforts to take effect and for inflation to fall toward the Fed’s long-term goal of 2%, suggesting cash yields could remain high into 2024.
Source: Bloomberg L.P. and the US Federal Reserve. These figures are shown for illustrative purposes only and are not guaranteed. They do not reflect taxes or investment/product fees or expenses, which would reduce the figures shown here. Past performance is not a guarantee of future results.
There may be even better opportunities in fixed income
While the Fed’s policy rates have a heavy influence on cash investment yields, markets determine yields on fixed income investments beyond the short end of the curve. As such, we believe the time is now to reset fixed income allocations transformed into cash investments by negative yields in 2022.
For example, the Bloomberg US Aggregate Index offered a yield of 4.75% on June 28, near the highest level since 2009. Fixed income is as attractive as cash yields, if not more in our view.
The higher yield alone sets up solid total returns for fixed income. Plus, with CPI inflation well off its highs, bond yields could settle lower, adding positive price returns should yields decline. This suggests now could be an attractive time for total return investors to own fixed income rather than cash.
The time may be right for investors seeking income from their fixed income portfolios as well. By taking a buy-and-hold approach to bonds, investors can lock in today’s elevated yields for many years. While cash investment yields may be slightly higher today, we anticipate cash yields to fall once the Fed’s battle with inflation is won. By that time, intermediate and long-term bond yields may be substantially lower, reflecting a missed opportunity to lock in healthy yields for longer.
Why the time is now to consider fixed income
The window to rebuild fixed income allocations has been open since October when Bloomberg US Aggregate Yields topped out at 5.21%. Subsequent peaks in yield have been lower, setting lower highs each time yields rise. But current levels still represent a solid opportunity — and the window soon may be closing.
The cost of sitting in cash rather than fixed income in long-term portfolios may be significant. Investors are potentially giving up the opportunity to:
- Capture the extra total returns as intermediate yields decline
- Lock in greater income potential at elevated yields today
Source: Bloomberg L.P. These figures are shown for illustrative purposes only and are not guaranteed. They do not reflect taxes or investment/product fees or expenses, which would reduce the figures shown here. An index is a statistical composite that is not managed. It is not possible to invest directly in an index. Past performance is not a guarantee of future results.
The bottom line: Cash is not always king
When you can earn 5% in cash investments, why take the risk of medium and long-term fixed income that earn somewhat lower yields? Especially after experiencing sharply negative returns on fixed income in 2022. Why take the risk?
There is a place for cash and shifting excess transactional cash into cash investments makes a lot of sense today. But fixed income allocations within long-term portfolios typically benefit from the interest rate sensitivity of fixed income investments as a stabilizer for diversified portfolios.
Talk to your advisor about fixed income opportunities
Your Ameriprise financial advisor will determine the appropriate level of cash for your portfolio and find fixed income opportunities that could help you reach your short- and long-term financial goals.