A sampling of sentiments about short-term cash investments as yields respond to Fed rate cut.
The Federal Reserve’s 50-basis-point rate cut last week is generating plenty of buzz among treasury teams responsible for investing excess cash who have made the most of short-term rates topping 5% following years of yields near zero. The beginning of rate cuts raises the question for some cash investment managers of when to start extending duration.
- More context: After the Fed started raising rates in 2022, an inverted yield curve meant it didn’t pay to take on additional risk by extending the duration of fixed-income portfolios. That’s why most corporations opted to stay very short.
- “Organizations have remained heavily invested in ultrashort, highly liquid investments,” Matt Thomas, who leads NeuGroup for Cash Investments, told us last week. “They’ve been prepared to start to shift holdings for the past six to nine months.”
- But some investors didn’t wait. In taking the pulse of NeuGroup members in the wake of the Fed’s first rate cut in five years, NeuGroup Insights encountered a member who took a different tact, one he says has paid off.
Extending with barbells. “We extended our portfolio duration in anticipation of the start of monetary policy normalization early in the year via Treasuries, agencies and corporate bonds,” this member said. “The strategy has worked to our advantage.”
- We asked how it worked. “The answer is a barbell approach,” he said. “We were gradually locking in 2026s and 2027s with great rates while taking advantage of the highest yielding opportunities on the ultrashort end. The longer bonds will significantly outperform the short end from both a total return and yield perspective moving forward.”
- This member said the Fed should have cut rates 25 basis points. “If the Fed does not want the market to embed 50-basis-point cuts in expectations moving forward, why start there?” he asked. “A gradual series of 25- basis-points cuts provides many benefits, perhaps most importantly, predictability. Why introduce unnecessary volatility that may undermine the soft landing?”
- He said time will tell if the Fed’s front-loaded interest rate cuts end up being the right policy decision.
Waiting to move. Another member we reached, a treasurer with 25 years of experience, is taking a more typical approach. His company moved to “an extremely short duration” beginning in December 2021. “We have kept that strategy in place while fed funds went up to 5.25% and held steady there for the last year,” he said.
- “We had the highest return with no credit or duration risk. Now, as the fed funds rate moves lower, there will be opportunities to move out (take duration) and take credit risk to enhance yields (we have had corporate credit risk in our portfolio so this is not new).”
- We asked when he expects the yield curve to start to normalize and offer those opportunities. “Most likely next year—Q1 or Q2,” he said.
- A third member described a stance and situation that falls somewhere between his peers. “We stayed short from 2021 to June 2023, then started to lengthen. However, we have had cash needs that have resulted in the portfolio moving shorter than we would have liked during the summer.
- “The rate cuts have not changed our investing approach of working to get slightly longer duration relative to our benchmarks.”
Money market funds? Before the Fed rate cut, the Wall Street Journal ran a story that included the observation that following a rate cut, corporates are expected to move more cash into money market funds (MMFs) because they have a weighted average maturity of around 30 days, unlike investments that reprice immediately, like treasury bills or bank deposits.
- After last week’s cut, the assistant treasurer of a mega-cap corporate observed that while that may be true on a short-term basis, lower rates “reduce the attractiveness of money market funds, and requires us to better balance returns on assets versus short-term liabilities. We may reduce the amount of cash holdings relative to longer-dated commercial paper borrowings.”
- That said, he recommends a conservative approach where MMFs play a key role. “I would advise that treasurers don’t try to over-engineer for returns on their liquidity plans. Cash for most of Corporate America is aimed to meet contingency needs and as such, should be kept in safe, highly liquid and diversified assets such as MMFs.”
