Cash was king - but these bonds are outperforming ahead of Fed rate cuts

MW Cash was king - but these bonds are outperforming ahead of Fed rate cuts

By Joy Wiltermuth

A popular 'T-bill and chill' trade is about to become a lot less cool as the Fed starts lowering interest rates

Investors have been reluctant to give up on "cash" yielding close to 5% from Treasury bills, money-market funds and other short-term plays since the Federal Reserve began jacking up interest rates two years ago.

That's been the case even as yields on 3-month Treasury bills BX:TMUBMUSD03M have been falling, dropping to about 4.85% as of Tuesday from a high of about 5.5% in October of last year.

"T-bill and chill, that's already started to change from a return standpoint," said Gene Tannuzzo, global head of fixed income at Columbia Threadneedle Investments, in a press briefing on Tuesday.

While short-term yields still look attractive from a historical perspective, Tannuzzo pointed to segments of the bond market that already have been outperforming cash in the run-up to expected rate cuts.

While cash returned about 9% since December 2022 through August of this year, investment-grade bonds kicked off about 12.3% while riskier high-yield "junk bonds" produced about 20.6%.

Tannuzzo isn't advocating that investors jump headfirst into any kind of bond for higher yield, especially with the U.S. economy showing signs of slowing and spreads, or extra compensation for bond investors, still near historic lows.

Related: How the Fed's rate decision could unravel a big bond-market recession bet

But he does expect the Fed's eventual path on rates to stoke volatility in safer parts of the market like investment-grade bonds AGG, agency mortgage-backed securities MBB and municipal bonds MUB, which could turn into buying opportunities.

"As short-term yields come down, it changes the shape of the yield-curve," Tannuzzo said, making longer-term fixed income more attractive.

Read: Interest rates are dropping. Why so many investors are clinging to cash, CDs and savings accounts.

The 10-year Treasury yield BX:TMUBMUSD10Y was edging higher to 3.64% on Tuesday, but still near the lows of the year. Stocks were mixed, with the Dow Jones Industrial Average DJIA and S&P 500 SPX struggling for direction and the Nasdaq Composite COMP up 0.1%, according to FactSet.

-Joy Wiltermuth

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September 17, 2024 15:21 ET (19:21 GMT)

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