There’s a party in the short-end of the yield curve — and as much as it may pain income-seeking investors, it’s time to think about what will happen when the Federal Reserve takes away the punchbowl. The Fed’s rate-hiking campaign gave investors an opportunity they haven’t seen in years: Risk-free returns are finally interesting. Six-month Treasurys are yielding 5.5%, while a bevy of money market funds are offering 7-day yields exceeding 5%, according to Crane Data . US6M US2Y 1Y line U.S. 6-month vs 2-year Treasurys As investors look ahead to the central bank’s meetings, traders largely anticipate policymakers will hold rates steady in September but see roughly 40% odds that another hike could be in the cards for November, according to the CME FedWatch Tool . However, at some point, rates will come down — and investors hiding in short-term, high-yielding assets could find themselves with no place to go. “The six-month T-bill is where it’s at for the highest interest rate and the shortest time commitment, but we’ve been having that conversation [with clients]: that if the Fed is expected to cut rates in 2024, should we lock in a higher rate for a longer term?” said Crystal Cox, certified financial planner and senior vice president at Wealthspire Advisors. Difficult conversations The Fed’s move to cut rates would lower yields on a range of instruments, including money market funds, Treasury bills and savings accounts. That means investors could be left with few places to go for attractive yields in a lower rate environment as their shorter-term assets mature — known as reinvestment risk. Another threat facing individuals who camp out in cash-like investments is that the interest they’re receiving likely won’t keep up with inflation over the long term. That means they’ll have to start thinking about redeploying some of their money into stocks for better return prospects over time or buying up longer-dated fixed income assets so they can lock in some yield, and look to potential capital gains. Even as the argument for adding duration to a fixed income portfolio — generally, that means buying longer-dated bonds with greater price sensitivity to changes in rate policy — makes sense on paper, investors may flinch at the idea. “With yields at 5.4%, the question is what realistic potential upside do I need to see to take the trade-off of a ‘guaranteed’ return with no volatility and easy accessibility?” said Matthew McKay, a CFP and portfolio manager at Briaud Financial Advisors. McKay’s clients are largely investors who are transitioning into retirement and are risk averse. “They don’t need to hit homers, and they want to maintain their purchasing power,” he said. To that end, clients have snapped up 2-year CDs to lock in some duration — no more than 5% of their portfolio, McKay noted. Recognizing priorities Bond ladders are another tool to use. This strategy involves a portfolio of bonds with varying maturities. As individual issues mature, investors reinvest the proceeds into new bonds. The benefit of laddering when rates are high is that the longer-dated bonds will have already locked in the higher yields. “We have been talking to people about not chasing the short end too much,” said Jerrod Pearce, CFP and partner at Creative Planning. He noted that now is the “best time in a long time to be buying more intermediate term bonds.” For ladders, Pearce prefers a duration of four to six years on investment grade corporates, but he will go out to eight or nine years on ladders of municipal bonds. “Lock in those returns for a long period of time, and when rates come down — be it a year from now or three years from now — the value of the bonds goes up,” he said. For investors who want the comfort of higher yields on excess cash, moving to a 12-to-18-month CD allows them to lock in rates for a little more time, said Wealthspire’s Cox. Longer-term clients, however, have an even more complex question to answer: If they stay in CDs and T-bills, how will they feel if they miss the opportunity of buying up longer-duration assets? “The strategy really depends on the client: Are you going to experience FOMO if bond funds are up 8% and you’re stuck at a 5.5% Treasury bill rate?” she asked.
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