Yields are stable, Fed interest-rate cuts are off the table, and increasing market volatility is adding to the allure of cash-like investments.
Money-market funds have a lot going for them right now. Not only do they offer safety from turbulent markets, but investors can also earn an attractive 3.45% yield, according to Crane’s index of the 100 largest money-market funds. That’s down from 3.58% at the start of the year, but stable for the past few months and quite a bit higher than most investors expected for midyear.
The outlook at the end of February was that the Federal Reserve would lower interest rates three times through mid-2027, which would have led to a drop in money-market fund yields. But the start of the Iran war led to higher energy prices and a jump in inflation expectations, reducing the odds that the Fed would lower rates. The central bank’s next meeting is June 17, and investors’ expectations are that rates will remain stable. Later this year, there may even be a hike.
“The base case assumption that the return you were going to get from money funds would be lower has been flipped on its head,” says Matthew Bartolini, global head of research strategists at State Street Investment Management. His firm launched the State Street Prime Money Market exchange-traded fund in February. It yields 3.61% and allows for intraday trading, something that investors with portfolios made up of ETFs were looking for in a money-market fund. BlackRock also launched a money-market fund around the same time: the iShares Prime Money Market ETF, which now yields 3.63%.
Meanwhile, the yield on the S&P 500 index has fallen to just 1.1% as stock prices have risen a lot faster than dividend growth in recent years.
The iShares Core U.S. Aggregate Bond ETF, which tracks a benchmark of U.S. investment-grade bonds, yields 4.46%, but is down slightly year to date since bond prices move inversely to interest rates. If inflation expectations increase from here, bond prices may fall, suggesting to strategists at Charles Schwab that taking on less interest-rate risk by allocating to some shorter-term bonds makes sense.
Given the recent interest-rate and stock market volatility, it isn’t surprising that investors have clung to the safety of money-market funds. Total money-market fund assets remain near a record at $7.9 trillion for the week ended on June 10, according to the Investment Company Institute. The recommendation to “T-Bill and Chill,” by DoubleLine CEO Jeffrey Gundlach in October 2023 remains as current as ever.
One problem: investors today generally have too much money in cash, says Daniel Ivascyn, chief investment officer of asset manager Pimco. His sees a wider-than-usual range of possible outcomes for the economy and markets in the next few years due to geopolitical risks as well as questions about the impact of artificial intelligence. Interest rates, which now seem bound to head higher, could actually fall if there is an economic shock. That could prompt the Fed to lower rates, leaving investors sitting in money-market funds that yield just 2%, for example.
In that scenario, investors who took on some interest-rate risk by buying longer term maturities would be seeing gains in addition to having locked in higher yields for longer, Ivascyn says. His advice: Diversify fixed-income portfolios across geographies and asset classes to reduce risk while benefiting from higher yields. Don’t just sit in money-market funds.
That doesn’t mean you can’t own some, but what’s the right amount? U.S. Bank’s wealth management arm recommends that investors put 2% to 10% of their portfolio in cash depending on their liquidity needs.
For retirees, it makes sense to have the next year’s spending requirements in cash, suggests Cooper Howard, director of fixed-income research and strategy at Charles Schwab. For people accumulating savings, “there’s no one size fits all,” he says. “The right allocation depends on your risk tolerance and risk capacity.”
Write to Amey Stone at amey.stone@barrons.com