As rate hikes near end, historic investor opportunity may begin

To say this has been an interesting year in financial markets is an understatement. Equities have been stronger than most expected, and the 10-year U.S. Treasury yield is up 37 basis points as of September 13. So where are we now as we head into the homestretch of 2023? I believe we’re on the cusp of a major transition, one where long-term investors can find attractive income opportunities as central banks pivot from restrictive monetary policy to something that looks much more benign.

Last year was shocking to many in the investment community: It marked the first time in at least 45 years that both stocks and bonds posted negative returns in a calendar year. Battling high inflation, the Federal Reserve raised interest rates aggressively. Those hikes hurt absolute results across the board. The usual role of high-quality bonds to provide diversification from stock market volatility — something investors rely on — broke down.

Turbulent markets in 2022, plus the prospect of relatively high yields in money markets, led investors to flock to cash-like alternatives. Money market funds were at an all-time high of $5.6 trillion as of September 6, according to the Investment Company Institute. Cash investments still look compelling to many investors today, but the Fed appears to be nearing a turning point. History teaches us that this may be an opportune time to shift back to stocks and bonds.

Will the Fed raise interest rates again?

Nobody knows exactly when the Fed will stop raising rates. However, both markets and the Fed itself project its key policy rate to peak near current levels and then decline around 100 basis points by the end of 2024.

If you believe the Fed is finished or nearly there, what does history tell us? An analysis of the end of the last four Fed hiking cycles shows that cash investments decayed while stocks and bonds flourished.

History shows cash has decayed when Fed hikes end

Sitting in money market funds today may feel comfortable with a roughly 5% yield, based on the benchmark 3-month Treasury, especially after an extended period of experimental zero interest rate policy post-global financial crisis. But the benefit of remaining in cash at current yields is eroded by today’s moderate inflation. Additionally, these cash-like holdings may see little additional upside as the Fed finishes hiking rates.

This is where the math matters. History shows that in the 18 months after the Fed ended hikes in the last four cycles, yields on cash-like investments have traditionally decayed rapidly. The 3-month Treasury yield, a benchmark Treasury security with a yield similar to cash-like investments, fell an average of 2.5%. If history were to repeat itself, money market fund yields would decline, and investors would be better served by being actively invested in stocks and bonds.