Why We Think Now May Be the Time to Reposition Cash Investments
Yields on cash equivalents are likely to fall amid Fed rate-cutting, highlighting opportunities among short-duration bonds.
Key Takeaways
After driving interest rates to multiyear highs, the Fed finally launched a rate-cut campaign, with implications for cash investments and bonds.
The recent high yields on cash-equivalent accounts are likely to diminish, underscoring the potential of high-quality, short-duration bonds.
Shorter-duration fixed-income securities can help you respond to the changing interest rate backdrop while aiming for solid yield and return potential.
The Federal Reserve’s (Fed’s) latest rate-hike campaign prompted investors to pour more than $6.4 trillion into cash investments.1 The 16-month push propelled interest rates more than 5 percentage points higher and lifted yields on cash equivalents to multiyear highs.
Now, after holding rates at a 23-year high for more than a year, the Fed is on a different course. Policymakers indicated their half-point rate cut in September was the start of an easing campaign likely to last through 2025. For CD, savings and other cash-equivalent accounts, this course change signals lower yields ahead, while highlighting the potential benefits of shorter-duration bonds.
The Cost of Staying in Cash May Be Rising
In a declining interest-rate environment, reinvesting in cash equivalents may lead to lower income — a dynamic known as reinvestment risk. This refers to the possibility that investors will have to reinvest cash flows at a lower yield than they’re currently earning.
Yields on Treasury bills, CDs and other cash equivalents typically move in tandem with the federal funds rate. So, when the Fed is cutting rates, yields on these popular savings vehicles generally follow suit, as Figure 1 illustrates. This means less monthly income for cash investment accounts.
Figure 1 | Cash Equivalent Yields Have Historically Fallen Quickly After the Fed Starts Cutting Rates
Data from 6/30/1974 – 9/16/2006. Source: FactSet. Average cash yield change during rate-cutting cycles since 1974 represented by the three-month U.S. Treasury bill.
How Bond Yields Can Offset Reinvestment Risk
The three-year backdrop of high interest rates not only boosted cash equivalent yields — but also lifted yields across the bond market. As a result, yields on investment-grade bonds have remained well above their levels of 10 years ago, as Figure 2 demonstrates.
Figure 2 | We Believe Recent Yields Appear Attractive
Data as of 9/30/2024. Source: FactSet. The following terms referenced in the chart are defined in our glossary: asset-backed securities (ABS), commercial mortgage-backed securities (CMBS), duration, investment grade (IG) corporate bonds and the Bloomberg U.S. Aggregate Bond Index. Yield to worst is a measure of the lowest possible yield an issuer can pay on a callable bond without defaulting. ABS are represented by the Bloomberg U.S. Aggregate Securitized ABS Index, a subset of the Bloomberg U.S. Aggregate Bond Index that tracks ABS; CMBS are represented by the Bloomberg U.S. Aggregate Securitized CMBS Index, a subset of the Bloomberg U.S. Aggregate Bond Index that tracks CMBS; IG corporate bonds are represented by the Bloomberg U.S. Corporate Bond Index. Past performance is no guarantee of future results.
While Fed rate cuts have historically had the greatest effect on cash equivalent yields, they also affect bond yields. But unlike cash equivalents, bonds offer price appreciation potential when yields decline.
Given today’s yield environment, bonds may help mitigate reinvestment risk by:
Securing and locking in today’s yields.
Adding duration, which can generate price appreciation and total return potential when interest rates fall.
Shorter-Duration Strategies May Help Manage Interest-Rate Risk
While the Fed funds rate has retreated from its recent peak, the timetable for future Fed rate cuts remains unclear. Inflation, employment and other economic data will influence the Fed’s course, which could trigger market and interest-rate volatility along the way.
In our view, short-duration strategies offer potential yield and total return advantages while reducing exposure to interest rate volatility. History has demonstrated that short-duration strategies have fared well after interest rates drop from their peak levels, as Figure 3 highlights.
Figure 3 | Average Returns Following Peak CD Rates
Data from 8/1/1984 – 12/31/2022. Source: Morningstar, Bankrate. Past performance is no guarantee of future results.
Short-Term Bond is representative of the average return of the U.S. Short-Term Bond Morningstar Category.
Opportunities to Help Combat Reinvestment Risk
While the Fed has made clear its intention to reduce interest rates, it hasn’t outlined a specific pace. Nevertheless, we believe it’s clear that reinvestment risk is rising, underscoring the characteristics that high-quality, short-duration bonds offer.
In our view, funds that focus on these securities may help adapt to the growing threat of reinvestment risk. Such funds include:
American Century Short Duration Strategic Income Fund/American Century Strategic Income ETF
A portfolio of short-duration securities seeking income and return potential that exceeds those of cash investments by opportunistically allocating across multiple bond market sectors.
American Century Short-Duration Inflation Protection Fund
A portfolio designed to help improve purchasing power and keep pace with inflation by investing primarily in short-duration Treasury inflation-protected securities (TIPS).
American Century Short Duration Fund
A portfolio that seeks to maximize total return and current income and manage interest rate risk primarily through investments in short-maturity corporate, government and securitized bonds.
Authors
Consider realigning your cash investments.
Explore our entire suite of American Century Fixed-Income funds.
Investment Company Institute, “Money Market Fund Assets,” News Release, October 24, 2024.
Exchange Traded Funds (ETFs) are bought and sold through exchange trading at market price (not NAV), and are not individually redeemed from the fund. Shares may trade at a premium or discount to their NAV in the secondary market. Brokerage commissions will reduce returns.
You should consider the fund's investment objectives, risks, charges and expenses carefully before you invest. The fund's prospectus or summary prospectus, which can be obtained by visiting americancentury.com/etfs, contains this and other information about the fund, and should be read carefully before investing. Investments are subject to market risk.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
Generally, as interest rates rise, the value of the bonds held in the fund will decline. The opposite is true when interest rates decline.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
Exchange Traded Funds (ETFs): Foreside Fund Services, LLC - Distributor, not affiliated with American Century Investment Services, Inc.
Mutual Funds: American Century Investment Services, Inc., Distributor.