“T-Bill and Chill” is a hard habit for investors to break

(Bloomberg) — For more than a year, it’s been the simplest idea: Park your money in super-safe T-bills, earn returns of more than 5 percent, rinse and repeat. Or, as billionaire bond investor Jeffrey Gundlach put it last October, “T-bill and chill.”

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Even now, with Federal Reserve officials poised to cut benchmark interest rates from a two-decade high — a move that would instantly lower yields on bills and other short-term debt — money market funds are thriving. They raised $106 billion this month alone, and their balances of $6.24 trillion have never been higher.

Cash-equivalent investors seem perfectly happy to stay where they are for now, despite repeated advice to add exposure to longer-term bonds from Pimco and BlackRock Inc. – of course, the bond managers themselves. But their point is that while cash yields have nowhere to go but down, longer-dated debt will benefit from capital gains in an environment of deep rate cuts.

“Logistically, it doesn’t make a lot of sense to have more than $6 trillion in money market funds if yields are going to fall,” said Kathy Jones, chief fixed income strategist at Charles Schwab & Co. “We’ve talked a lot about rate cuts and they haven’t happened, so there might be a lot of people who are actually waiting to see it happen.”

During this year’s bond volatility crises, cash was a good place to be. Money market rates, which are removed from the Fed’s current 5.25% to 5.5% policy band, were steady and offered no surprises.

That is about to change. Fed Chairman Jerome Powell signaled last week that interest rate cuts would occur in September. With inflation falling, “the time has come for policy to adjust,” he said, adding that “the direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook and the balance of risks. .”

Money markets may continue to appeal, it is the scope of the rate cuts that matter. Just 1 percentage point of cuts, for example, would still leave bill rates in the 4% range, an attractive return – especially after years of near-zero rates before the latest tightening cycle, and at a time when US long-term bonds yield much less. This may explain why retail investors are in no rush to change their holdings.

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“For the first time in recent memory, cash is actually providing some yield, and I understand why people are kind of gravitating toward that,” said John Queen, a portfolio manager at Capital Group, which oversees $2.5 trillion in assets. of dollars. As well as it has done recently, Queen recommends a classic diversification strategy, investing in a mix of cash, stocks and fixed income.

Of the $6.24 trillion in cash parked in money market funds, about 60 percent comes from corporations that stockpiled cash in the wake of the pandemic, while the rest comes from familiar investors who are content to continue earning more than what they can earn just by keeping this money in the bank. Those returns are also significantly higher than what investors can get by switching to longer-dated Treasuries — though nothing like the stock market’s gains.

Even after the Fed starts lowering borrowing costs, money market funds should continue to attract at least some money from retail investors. That’s because they will still offer higher returns than banks and attract institutions that prefer to outsource cash management.

For some investors who enjoy high rates on short-term savings, there’s a growing recognition that this won’t last forever, and they’re becoming increasingly wary of the day cash returns plummet.

Steven Roge, chief investment officer at RW Roge & Co, a private wealth manager with $350 million in assets, says that for much of this year, the toughest conversations with clients have been about learning the risk of reinvestment from staying too long in a money market fund or high-yield savings account.

“Reinvesting in bond funds over time, it’s been a difficult conversation,” Roge said. “These talks are getting easier with Fed rate cuts on the horizon.”

The missed opportunity for cash investors is that, unlike bills, bonds generate capital gains from price appreciation as interest rates fall.

Bond managers point to how a 10-year Treasury note, yielding less than 4 percent today, has already benefited from capital gains since the benchmark topped 5 percent less than a year ago. A Bloomberg index of 7- to 10-year Treasuries has gained 13.3 percent versus a cash yield of 4.5 percent since last October.

Of course, for some the choice isn’t just between bills and longer-term bonds. Berkshire Hathaway Inc. of Warren Buffett increased its Treasury bill holdings to $234 billion in the second quarter after cashing in on investments in stocks including Apple Inc. For investors like him, holding cash equivalents while rates are still reasonable makes sense until further bargains in stocks. appear.

But from a fixed income perspective, the math still works out to hold a 10-year Treasury, which is now yielding about 4% over cash, should the bond market rise to 3% as the Fed tapers towards a neutral policy. Longer-dated Treasuries would enjoy a double-digit return from price appreciation and coupon interest.

“In that scenario, no, you’re not better off in cash,” said Neil Sutherland, portfolio manager at Schroder Investment Management. “I don’t think it’s unreasonable to think that the 10-year could go down to 3% and in that environment you get to double-digit yields pretty quickly.”

Digging

Don’t tell that to Bill Eigen, manager of the $10 billion JPMorgan Strategic Income Opportunities Fund. For him, the idea of ​​moving money into a 10-year US note, currently yielding around 3.82%, has little appeal. His fund held 54 percent in cash at the end of July, according to its latest filing.

“You can get half of 5% in cash, you can get 6% in short-term investment-grade floating rate,” Eigen said. “I won’t lend to the government for 10 years and get paid less.”

Eigen has been hoarding cash for some time, a move that has helped the fund return 9% over the past three years, compared with a 6% loss in the Bloomberg Agg index. But that was then.

As cash-equivalent rates begin to fall—and by all accounts they will—”T-bilt and chill” won’t be so simple.

“Once investors look at what they’re getting, they’re going to decide where they’re at is not that attractive anymore,” Schwab’s Jones said.

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