Bonds Rethinking cash management as short-term interest rates pop

Steven D. Lotwin Erica Salvay

November 12, 2026

A rising rate environment has reshaped the yield curve in ways that may mark an end to a one-size-fits-all approach to cash and liquidity.

 

Money market holdings reached a record $8 trillion in November, capping off a rise that began during the pandemic and accelerated amid disruptions ranging from tariffs to the Iran war and inflation concerns. Amid this flight to safety, cash-like instruments such as money market funds and certificates of deposit have served as an attractive asset class offering relatively elevated yields. Holdings have also grown alongside rising equity markets, with cash allocations growing in lockstep with heightened portfolio valuations.

 

Investors are often looking to cash for capital preservation and flexibility to meet near-term obligations. Still, not every dollar of liquidity serves the same purpose. Some assets support daily expenditures and require immediate access. Others are reserved for future expenditures, capital-intensive projects or obligations that may be months or years away. Looking at liquidity through the lens of purpose unlocks opportunities that could push investors further out across the yield curve.

 

Opportunities at the front end of the curve are strengthening amid a reshaping of the Treasury yield curve. The 1-month to 2-year mark has been particularly impacted by the resurfacing of inflation concerns in the wake of the Iran war. In April, the slope of the front end of the curve turned positive – ending an inversion that took hold in mid-2022 and persisted through the U.S. Federal Reserve’s rate tightening and easing cycles from 2022 through the end of 2025. 

The front end of the yield curve has steepened dramatically

Line chart comparing the US Treasury yield curve on 2/28/26 and 10/26/26. The later curve is higher and upward sloping, rising from about 4.0% at 1 month to 5.4% at 20 years before leveling near 5.3% at 30 years. The earlier curve rises from about 3.7% at 1 month to 4.6% at 30 years.

Source: Bloomberg. As of 10/26/26. Past results are not predictive of results in future periods.

The curve has steepened meaningfully, with the difference between 3-month Treasury bills and 2-year Treasuries moving from negative 28 basis points in late February 2026 to 40 basis points in early November. The shift marks an end to the unusual advantage that cash-like holdings held over longer duration investments.

A framework for liquidity

Amid the recent reshaping of the yield curve, investors have more incentive to differentiate how they invest cash assets. Investors have traditionally divided liquidity into operating, reserve and strategic buckets, with each segment carrying various profiles for everything from the investment horizon to the liquidity profile and the return objectives.

 

To put that framework to work, investors can ask three questions: When will the capital be needed? How certain is that timing? How much interim price volatility can be tolerated? The answers help determine how cash balances might be segmented and invested.

 

In practice, liquidity often operates more on a spectrum rather than falling into three discrete buckets. At one end of the spectrum sits operating liquidity, where immediate access and principal stability are the primary objectives. Further along are reserve balances, which may support near-term liabilities or expenditures and can potentially tolerate modest additional volatility in exchange for greater income potential. At the far end of the spectrum are strategic balances, where longer investment horizons provide flexibility to stretch out duration in the pursuit of enhanced returns. 

Investment priorities vary across liquidity balances

Liquidity framework for a hypothetical $100 million portfolio. Operating liquidity covers 0–6 months, with high liquidity requirements, lower return objective and highest principal stability. Reserve liquidity covers 6–18 months, with moderate liquidity requirements and return objective, and high principal stability. Strategic liquidity covers 1–3 years, with lower liquidity requirements, higher return objective and important principal stability.

Source: Capital Group. For illustrative purposes only.

In our view, sizing each allocation should begin with determining how much capital sits along this spectrum and how much risk it can take. The appropriate mix will differ by investor, reflecting the predictability of spending and the resources available to meet unexpected demands. That mix should be revisited as obligations approach or circumstances change.

 

Operating liquidity prioritizes dependable access and principal stability over additional return. Money market and government funds may support daily and unexpected cash needs, while securities with maturities timed to coincide with upcoming obligations  may help fund predictable payments. Balances needed to meet near-term obligations should not take additional investment risk simply to increase yield potential.

 

Reserve liquidity balances accessibility, potential for capital preservation and income. Ultrashort bond strategies may offer additional income through diversified exposure to high-quality corporate credit, securitized debt and short-maturity instruments such as commercial paper. Modest duration and selective credit exposure may be appropriate where spending needs and tolerance for interim losses allow, not simply because yields may be higher.

 

Strategic liquidity balances longer term return potential with future access needs. Short-duration bond allocations, which may include a mix of Treasuries, investment-grade (BBB/Baa and above) corporate bonds and securitized assets may support that objective, with duration typically between one and three years. Additional duration and credit exposure should reflect an investor’s ability to tolerate interim volatility, losses and some capacity to defer withdrawals, not just a longer investment horizon.

 

The cash allocation decision has become more consequential as the yield advantage on ultrashort and short-duration bond funds has steadily widened over the past year. As of September 30, ultrashort and short-term bond fund yields exceed 3-month Treasury bills by about 50 and 140 basis points, respectively, increasing the opportunity cost of treating all liquidity alike.

Yields on ultrashort and short-term bond funds remain relatively elevated

Line chart shows short-term bond yields with three lines representing bond yields for the 3-month Treasury bill, Morningstar Ultrashort Bond Category average and Morningstar short-term bond category average from June 2018 to September 2026. Bond yields surged during the Fed tightening cycle in 2022 to 2023. Since late 2022, short-term funds have offered consistently higher yields compared to three-month Treasury bills. As of September 30, 2026, the 3-month Treasury bill yielded 4.1%, the Morningstar Ultrashort Bond Category average yielded 4.6%, and the Morningstar Short-Term Bond Category average yielded 5.5%.

Sources: Bloomberg, Morningstar. As of 9/30/26. Short-term bond category and ultrashort bond category averages are provided by Morningstar and are based, respectively, on more than 75 short term bond funds and more than 140 ultrashort bond funds. Yields shown are yield to maturity. Past results are not predictive of results in future periods.

Not a riskless trade

As investors move along the risk spectrum, the potential for higher returns is typically accompanied by greater exposure to interest rate, credit and liquidity risks, making it important to understand the trade-offs involved.

 

With the Fed pivoting back to rate hikes in September, investors again face the prospect of a rising-rate environment, which has long been the double-edged sword of the bond world. On one side, rising rates can inflict price losses that can result in negative returns, as witnessed in 2022. On the other side, higher rates lead to higher yields which set investors up for robust income potential, attractive reinvestment opportunities and can offer incremental cushion against further rate increases. 

Starting yields are meaningfully higher than 2021, helping to provide buffer against rate increases

Bar chart of hypothetical gains and losses under rising-yield scenarios for the Bloomberg U.S. Government/Credit 1–3 Years Index. Starting yields are 0.8% for December 2021 and 4.7% for October 2026. At the October 2026 starting yield, the hypothetical gain is 4.3% with a 25-basis-point increase, 3.8% with a 50-basis-point increase, 3.4% with a 75-basis-point increase and 2.9% with a 100-basis-point increase. Returns from the December 2021 starting yield fall to 0.3% with a 25-basis-point increase, negative 0.2% with a 50-basis-point increase, negative 0.6% with a 75-basis-point increase and negative 1.1% with a 100-basis-point increase.

Sources: Capital Group, Bloomberg. Hypothetical gains and losses are calculated as the change in the Bloomberg U.S. Gov/Credit 1-3 Years Index yield multiplied by the index’s average duration, which reached 1.92 years as of December 31, 2021, and 1.87 years as of September 30, 2026. Figures represent hypothetical gains and losses over a 12-month period.

Strong yields have helped ultrashort and short-term bonds weather this year’s rise in rates, with both the Morningstar Short Term Bond Category and Morningstar Ultrashort Bond Category posting gains for the year and exhibiting stability amid significant rate volatility.

 

The path forward for rates remains uncertain, with inflation trends, labor market conditions and economic growth all likely to influence the Fed’s decisions in the months ahead. Our U.S. interest rates team believes additional policy tightening may be warranted in the near term, though it does not view a prolonged hiking cycle as the most likely outcome. As of November 6, markets have already priced in about 45 basis points of hikes through year-end 2027, providing a measure of cushion from rising rates.

Moving beyond cash can help unlock income potential

Horizontal bars compare hypothetical annual income from a $1 million portfolio. An all-cash portfolio invested entirely in money market funds generates about $37,000. A bucketed portfolio with 25% in money market funds, 50% in ultrashort bond funds and 25% in short-term bond funds generates about $46,000.

Sources: Capital Group, Morningstar. As of 9/30/26. Hypothetical annual income is calculated using the yield for the respective categories over a 12-month period, with all other factors assumed constant. All yields shown are yield to worst except for money market fund yields, which are 7-day yields based on the Morningstar Prime Money Market Funds Category median. Yields as of 9/30/26 are 3.7% for money market funds; 4.6% for ultrashort bonds (Morningstar Ultrashort Bond Category average); and 5.5% for short-term bonds (Morningstar Short-term Bond Category average). Prime money market funds invest in floating-rate debt and commercial paper of non-Treasury assets, including those issued by corporations. Short-term bond category and ultrashort bond category averages are provided by Morningstar and are based, respectively, on more than 75 short term bond funds and more than 140 ultrashort bond funds. For illustrative purposes only. 

In terms of credit risk, not all ultrashort and short-term strategies pursue income in the same way. Some portfolios emphasize capital preservation, liquidity and selective credit exposure while others may rely more heavily on concentrated exposures, specific sectors or lower-rated instruments to generate additional yield. As a result, two strategies with similar durations may behave very differently during periods of market stress. Understanding the underlying holdings in a strategy remains critical.

 

Liquidity risk also matters: An investor should not have to sell holdings at an unfavorable price or amid challenging market conditions to generate cash. Operating balances require dependable access, while less-liquid exposures may be appropriate only for capital whose withdrawals can be deferred. A longer investment horizon does not remove the need to plan for unexpected cash demands.

 

In the ultrashort bond funds that we oversee, we maintain exposure across cash and commercial paper, corporate credit and securitized debt. Cash-like investments serve to anchor the portfolio, providing liquidity and flexibility to take selective credit exposure. When looking at credit, we stay within a measured allocation range to avoid large swings in portfolio risk. Holdings are predominantly investment-grade, though we see selective opportunities in areas such as “rising-star” high-yield issuers where our research suggests that credit quality is strengthening. Overall, we aim for a diversified mix of holdings that can withstand a range of market environments.

A fresh look at the front end

Purpose-based liquidity management is ultimately about aligning investment risk with the role that such capital is expected to play. Operating, reserve and strategic balances may share a common objective of capital preservation, but their liquidity requirements, investment horizons and return objectives can differ meaningfully. Applying the same investment approach across all liquidity assets may overlook incremental opportunities to optimize, especially amid a significant reshaping of the yield curve.

 

Perhaps surprisingly, one of the most conservative segments of the fixed income market may also be one of today’s most attractive opportunities. Healthy liquidity conditions, elevated front-end yields and a resilient economic backdrop have expanded the opportunity set for investors. The front end offers an opportunity to align capital more precisely with objectives — while continuing to prioritize liquidity, capital preservation and risk management.

Read important disclosures

Steven D. Lotwin is a fixed income portfolio manager with 24 years of industry experience (as of 12/31/2025). He holds an MBA from Stanford Graduate School of Business, a doctor of law from the UCLA School of Law and a bachelor's degree in economics from the Massachusetts Institute of Technology.

Erica Salvay is a fixed income investment director with 21 years of experience in the industry (as of 12/31/25). She holds a master's degree in investment management with distinction from Cass Business School and a bachelor's degree in economics from Washington University in St. Louis.

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Unlike mutual fund shares, investments in U.S. Treasuries are guaranteed by the U.S. government as to the payment of principal and interest. In addition, certificates of deposit (CDs) are FDIC-insured and, if held to maturity, offer a guaranteed return of principal. Although a money market fund seeks to preserve the value of an investments at $1.00 per share, it cannot guarantee it will do so. An investment in a money market fund is not a bank account and is not insured or guaranteed by the FDIC or any other government agency.

 

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Morningstar Short-Term Bond Category: Short-term bond portfolios invest primarily in corporate and other investment-grade U.S. fixed-income issues and typically have durations of 1.0 to 3.5 years. Morningstar calculates monthly breakpoints using the effective duration of the Morningstar Core Bond Index (MCBI) in determining duration assignment. Short-term is defined as 25% to 75% of the three-year average effective duration of the MCBI.

 

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