From Cash to Bonds: A Strategic Shift in Post-Pandemic Investing

As post-pandemic disruptions to markets and economies recede, long-term trends are reasserting themselves. One key signal that markets are returning to historical patterns appeared in November, when a common yield measure on the Bloomberg US Aggregate Index climbed above the Federal Reserve policy rate for the first time in more than a year.

It’s difficult to overstate how extraordinary it was to have a benchmark bond yield running below – sometimes well below – the federal funds rate for such an extended period. Prior to the pandemic, this had only happened four times in this century, and never for more than a few weeks at a stretch (see Figure 1).

Figure 1: Benchmark bond index yield once again exceeds Fed’s policy rate

Benchmark bond index yield once again exceeds Fed’s policy rate

This prolonged reversal in the usual market trend reflected not only the Fed’s restrictive policy, but also investors’ response to the extreme inflation spike and other consequences of the pandemic. Many investors retreated into cash – which offered yields not seen in decades along with perceived safety – and stayed there.

Changed circumstances

Two years later, the market landscape has transformed. Now that the Fed has embarked on a rate-cutting path, over-allocating in cash creates reinvestment risk as the assets rapidly and repeatedly turn over into lower-yielding versions of themselves.

At the same time, we witnessed a profound shift higher in bond yields from pandemic-era lows. Relative to cash, where yields are dwindling as interest rates drop, bonds offer a more compelling opportunity: Consider the same core bond index yield measured against another common proxy for cash, the yield on the 3-month U.S. Treasury (see Figure 2). Both cash and bonds offered attractive yields over the past two years, but cash investors by nature can’t lock in those yields for longer time periods – and since September, when the Fed cut its policy rate by 50 basis points (bps), the outlook for cash yields relative to core bonds has diminished sharply.

Figure 2: U.S. core bonds outyielding cash equivalents

U.S. core bonds outyielding cash equivalents