T-Bill and Chill: Running out of steam?

First, US money market balances have continued to grow, indicating that the adage “T-Bill and Chill” is alive and well. More recently, M2 – which includes cash and checking account deposits plus savings accounts, money market accounts, and time deposits of under a certain amount – has once again surpassed the peak reached in 2022. Some of the increase in money market balances will be simply a function of the bigger size of the economy, but notwithstanding that dynamic, the trend is clearly toward higher cash-like balances.

We think this is somewhat rational because the current Fed funds rate is 4-4.25% and with inflation running at 2.9%, the relatively chilled trade delivers over 1% in real returns. This contrasts with the Euro market, where cash currently delivers a negative real return.

Second, whilst the real return on cash and cash like instruments is positive, the static picture does not capture the future interest rate outlook. Specifically, we have 115 basis points (bps) of interest rate cuts priced in over the next 12 months. At the same time, inflation in the US is expected to be at 2.9% in 2026. So, whilst it is true that the front-end continues to deliver a real positive return, the expected rate cuts are likely to significantly reduce this excess over the next 12 months.

If recent history is any guide, as rate cuts start coming in effect, investors may be disadvantaged by staying in cash like instruments that compounds at ever lower rates. Instead, over the past two years in the Euro market, we’ve seen that as curves normalised and steepened, it was the combination of credit exposure, duration, and the decision to lock in attractive yields for longer that has outperformed cash, and by a significant margin.

Since November 2023, the ICE BofA 0-1 Year German Government Index – a widely used proxy for cash in euros – has delivered a total return of 5.6%. By contrast, Euro investment grade (IG) corporate bonds (ICE BofA Euro Corporate Index) and Euro high yield (HY) bonds (ICE BofA Euro High Yield Index) have generated a total return of 12.3% and 18.5%, respectively, giving excess returns over cash of 6.7% and 12.9%. To put it another way, those staying invested in credit since November 2023 have enjoyed roughly double the return on cash in IG and triple the return on cash in HY.

Looking ahead, and to the US dollar market, the current shape of the yield curve is not unlike that of the Bund curve two years ago, a period that followed a series of rate cuts totalling 200bps. At present, around 116bps of cuts are priced into the US over the next two years.
 

Clearly, there is never a guarantee that the UST curve will behave the same way as the Bund curve has over the past two years as further rate cuts take effect. However, what is certain is that cash will continue to earn a decreasing amount of yield with each cut, reducing real returns and likely pushing an increasing number of investors to other alternatives. We believe it will pay to get ahead of this trend, just as it did in Europe.