Barron's "Income Investing" column, entitled, "Don't Give Up on Bonds. Next Year Should Be Better," briefly mentions money funds at the end. The piece says, "Bond investors may take some solace as the year draws to a close; it couldn't have been much worse. Almost every area of fixed income suffered its steepest loss in decades. The Bloomberg U.S. Aggregate Bond Index fell about 11%. Even if it rallies a little from here, it's on track for its worst performance since the index's inception in 1976. Don't feel bad if you never saw the storm coming. Many bond pros didn't, either." (Note: Merry Christmas and Happy Holidays from Crane Data! Thanks for reading in 2022, and best wishes for 2023!)
After reviewing the carnage in bond funds, it explains, "The central bank boosted short-term rates seven times, from around zero percent to a recent range of 4.25% to 4.5%. A few more increases are expected in early 2023 -- likely to push the federal-funds rate to about 5.25% at its peak or 'terminal' level.... Where do we go from here? While we can't predict the path of rates, we can say that holding cash and proxies hasn't looked this good in years."
Barron's tells us, "A two-year Treasury bond was recently yielding 4.2%, compared with 0.8% at the start of 2022. The top-yielding nationally available money market and savings accounts are now at 4.35%, up from 0.55% in January, according to Greg McBride, chief financial analyst at Bankrate. FDIC-insured certificates of deposits also look appealing, though consumers should stick with the shorter terms. The highest-yielding one-year CDs yield 4.86%, versus 0.67% in January. But a five-year CD gets you just 4.6%."
They add, "Money-market mutual funds, available through brokerages, yield 3.9% and could top 4% as the Fed's latest 0.5 of a percentage point rate hike works its way into funds, says Peter Crane, president of Crane Data and Money Fund Intelligence. 'Yields should hit 4% within days,' he predicts. Granted, 4% still doesn't provide a 'real' inflation-adjusted return, considering that prices are rising a bit faster. But bond yields might now be close to an equilibrium with inflation, and could provide a small real return if inflation keeps easing in 2023."
In other news, Wells Fargo Securities' Vanessa Hubbard McMichael writes in a recent "Fixed Income Strategy" on "Front-end Investor Considerations: Recap of Client Conversations in 2022." She comments, "[W]e thought it may be more helpful to summarize thoughts and insights gleaned from investor conversations [from 2022].... Audiences' desired topics focused largely on three themes over this past year, with the rate environment and inflation dominating discussions. We categorize most of this year's dialogue in three categories: 1. General fixed income market update and more specifically, expectations for rates; 2. Strategies and considerations for investing cash in a high inflationary environment; and 3. Education on fixed income investment alternatives."
The Wells piece states, "As the Federal Reserve embarked on its most aggressive tightening cycle since at least the 80s to fight inflation that reached heights also not seen since the 80s, the conversation about when and where to allocate cash into fixed income markets was a highlight this year. There were ample opportunities to invest at higher rates with levels reaching heights not seen since 2007, plus front-end supply was elevated particularly across T-bills, Agency discount notes, certificates of deposit and commercial paper. While some cash investors were conflicted about the right time to allocate to fixed income markets this year, those who remained vigilant about maintaining portfolio structure and investing throughout the year found themselves largely in a position whereby interest income was once again something to take notice of."
It also tells us, "A client at a recent event shared that she 'was able to include interest income as a line item in forecasts once again,' something that was not a reality over the prior 2 years. The current environment is one whereby the potential for income generation on idle funds should not be minimalized or ignored. Every organization, public or private, large or small, can find a good use for additional income earned on balances not being actively deployed otherwise, particularly in an environment with heightened inflation and constrained resources."
Discussing "The cash see-saw," they write, "There was a cash balance see-saw of sorts taking place in our conversations with investors this year. While some organizations were not necessarily in a position of discussing investments in the context of excess cash balances, others were. Some organizations were revisiting prior deferred capital expenditures but still experiencing supply chain issues which further delayed spending, others were recipients of funds from debt financing or other capital raising, others found themselves in a position of net cash after years as a net borrower in capital markets, and there were still a number of organizations generally sitting on historically large cash balances due to some sort of COVID windfall. All of these conversations, no matter how they originated, were seeking the answer to a similar question: within the constraints of safety and liquidity, how do we capitalize on the rate environment in the right way?"
Wells says, "In many instances, these conversations led to the exploration of both new and existing fixed income alternatives. We worked with organizations developing new investment policy documents, revamping existing policy documents, or exploring existing permitted instruments that were historically underutilized. The most frequent asset class additions to investment policies this year were in the Deposit and Certificate of Deposit space (both FDIC-insured and non-FDIC insured), commercial paper (particularly tier-2 nonfinancial CP), and high-quality asset-backed securities. Most of the dialogue on asset class additions to policies was with corporate investors who have more flexibility for policy adjustments. Public entity investors abide by state statutes so unless there is a change in state law, investment parameters remain static."
They add, "Another dominant conversation related to diversification in 2022 was re-allocating some cash out of bank deposits or overnight fund options such as sweeps, money market funds or local government investment pools, and into other parts of the market. These conversations surfaced in efforts to reduce concentration risk for organizations overexposed to one counterparty (e.g., a financial institution) or one part of the market (e.g., MMFs/LGIPs, which are generally overnight instruments). Moreover, rates offered on these overnight alternatives, deposits, MMFs or LGIPs, lag overall fixed income markets, creating opportunity costs of forgone income. These sorts of overnight options are important vehicles for cash managers, so we certainly are not advocating that any organization completely forgo utilizing them but given the rate environment, many organizations have explored or are currently exploring alternatives and gaining comfort with utilizing multiple instruments to park cash."
Finally, Wells concludes, "This year has been quite a dynamic one and while we have not been able to offer a singular catch-all investment strategy to cash investors this year, our conversations were plentiful in dialogue with organizations recognizing the opportunity created for front-end buy-and-hold investors by the Federal Reserve. Yield is not the first objective for cash managers deploying cash but the level of rates on the front-end was difficult to ignore this year. Heading into 2023, the front-end of the curve will continue to offer value given the Fed's intent to pursue additional Federal Funds rate hikes and pause at elevated levels once the terminal rate is reached. Market pricing reflects a slightly different expectation for next year, as implied rates are lower by the end of 2023, despite the Fed's messaging. Eventually the market, the Fed and financial conditions will sync, but until then investors have only current levels and data with which to make investment decisions."
