An End to T-Bill and Chill?

Ever since the major developed market central banks began raising interest rates in late 2021 in response to the post-COVID surge in inflation, investors have been moving their capital to money market funds.

Coined ‘T-bill and chill’ by bond investor Jeffery Gundlach, investors have binged on this phenomenon for the last two years.¹ However, the Bank of England and the ECB have started cutting rates. Furthermore, with the US Federal Reserve (Fed) having cut interest rates by 50 basis points a few weeks ago, could it be worth investors trying something new?

The first cut is the deepest?

Compared with the quantitative easing era of low interest rates, investors have enjoyed parking their capital in cash. Who could blame them? Interest rates in the US and UK have risen from near zero to over 5% today. In the context of the volatility, we’ve seen in risk assets over the last two years, these rates have proven attractive to many investors.

The debate as to whether and how much the Fed could cut has been ongoing all year. In August, all eyes were on Fed Chair Jerome Powell’s speech at Jackson Hole, when he declared “The time has come for policy to adjust, and the direction of the travel is clear.”² Fast forward to today and Fed has not only cut rates notably, but the market is now expecting further easing this year.

Until now, it seems investors have favored taking a ‘wait and see’ approach. This has led to significant demand for money market funds, which saw record inflows of $1.2 trillion in 2023.³

Figure 1: Money market assets versus Fed funds rate

Source: Bloomberg. Data as of September 24, 2024.

Is cash still king?

From a theoretical perspective, there is both an opportunity cost and reinvestment risk from holding cash instead of bonds (or equities) during a rate-cutting cycle. As rates decline, bond prices tend to increase, and a bond investor can make a capital gain. On the other hand, an investor in short-term Treasury bills faces reinvestment risk, as a decline in interest rates may force them to reinvest at a lower rate once their bill matures.

The empirical evidence supports this theory. Examining the annualized excess returns of bonds over cash during rate-cutting cycles over the past 50 years, we can see a clear historic trend of outperformance. The outliers to this are the most recent financial crisis where risky asset prices were significantly impaired following the financial turmoil that was catalyzed by the collapse of Lehman Brothers in September 2008, and the COVID-19 pandemic, where investors flew to ‘safe’ haven assets when the WHO declared a global pandemic.

Figure 2: Bonds versus cash over cycle (annualized)

Source: Bloomberg. Data as of September 2024. ‘Bonds’ = US Corporate Total Return Index and ‘cash’ = cumulative growth of the Fed Funds rate. Past performance is not a guide to the future.

Why now?

Cycles are inherently hard to time, given the complex interplay between economic factors, lags and often unforeseen shocks. This can lead to uncertainty and market volatility as investors grapple with mixed signals from the data and policymakers.

However, history would suggest that the opportunity to capture the excess returns of bonds over cash doesn’t have to come just as the first cut is delivered. Indeed, as Figure 3 shows, with a two-year investment horizon, US corporate bonds have historically outperformed cash if investment is made up to 12 months after the first cut.

Figure 3: US Credit has historically outperformed cash during a Fed easing cycle

Source: Bloomberg. Data as of September 2024. ‘Bonds’ = US Corporate Total Return Index and ‘cash’ = cumulative growth of the Fed Funds rate. Past performance is not a guide to the future.

In short, investors have enjoyed ‘T-bill and chill’ for two years – but is this still true now that central banks have begun to cut rates?

We believe investors should really be asking: is now the time to move away from cash?

1. The terms ‘Treasury bills’ or ‘T-bills’ refer to short-term U.S. government debt obligations, and are often used interchangeably to mean ‘cash’ investments.
2. The Federal Reserve. 
3. Nearly $90bn pours into US money market funds ahead of expected rate cuts (ft.com)/EPFR data.

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