Is It Time to Say Goodbye to ‘T-Bill and Chill’?

24 January 2024

4 min read

Investors who wait too long to get off the sidelines may find they’ve missed out.

Bonds could see a big boost as central banks pivot toward rate cuts in 2024. Yet nearly $6 trillion is still sitting in money-market funds, a relic of the “T-bill and chill” strategy made popular in 2022, when central banks were aggressively hiking interest rates.

Here’s why we think the tide has turned for bonds.

Get Ahead of the Rush

Rolling Treasury bills seemed like a sensible idea in 2022. Cash rates were high, and bond prices were falling as central banks hiked aggressively, trying to get a grip on runaway inflation. With so many investors agreeing that cash was king, money market funds reached a record US$5.8 trillion in assets by the end of 2023.

But since October 2022, when the Federal Reserve’s overnight fed funds rate hit 4%, cash returns have failed to keep up with the bond market. From October 2022 through December 2023, cumulative returns for the US Treasury Bill 1–3 Month Index were 6.1%, compared with 7.5% for the Bloomberg US Aggregate Bond Index. The Bloomberg US Corporate High Yield Index fared even better, posting 18.2% over the period.

Now that the Fed appears poised to ease, many sidelined investors are looking to time their entry back into the bond market. Historically, as the Fed eased, cash flooded out of money markets and back into longer-term debt (Display).

Assets Tend to Flow Out of Money Market Funds During Easing Cycles

Money Market Fund Assets (USD Billions)

Following the last three easing cycles, assets in money market funds declined 19%, 35% and 10%, respectively.

Historical analysis does not guarantee future results.
Through December 31, 2023
Source: Morningstar, US Federal Reserve and AllianceBernstein (AB)

The resulting surge in demand for bonds from such shifts in flows typically drives bond prices up and yields down, helping to reinforce the drop in yields that accompanies central bank rate cuts. Because the amount of cash sitting on the sidelines today is unprecedented, the potential surge in demand for bonds is exceptionally high.

We think investors who are ahead in returning to bonds are well positioned for potential returns, because government bond yields often fall—and prices rise—before the Fed takes action.

Historically, in the three months prior to the first Fed rate cut, the yield on the 10-year US Treasury fell an average of 90 basis points. That’s why past investors captured the biggest returns when they invested several months prior to the start of the easing cycle (Display).

Historically, Early Birds Enjoyed the Strongest Bond Market Returns

Bloomberg US Aggregate Bond Index: Average 12-Month Forward Return (Percent)

The US Aggregate averaged 13.8% for the year starting 3 months before the 1st rate cut, and 8.6 starting one month after it.

Historical analysis does not guarantee future results.
Average is based on the following dates of first Fed rate cuts: September 20, 1984; June 7, 1989; July 6, 1995; January 3, 2001; September 18, 2007; and August 1, 2019.
As of December 31, 2023
Source: Bloomberg, US Federal Reserve and AB

The bond market already enjoyed a rally in late 2023 as investors anticipated an end to Fed rate hikes. But in our analysis, there’s plenty of room for yields to fall further—albeit with some bumps along the way—as growth slows and the Fed’s first rate cut nears.

Cash Yields May Disappoint

Meanwhile, investors who remain in money-market funds will likely see their cash yields decline, because cash yields are nearly perfectly correlated with the fed funds rate (Display).

Money Market Yields Correlate Nearly Perfectly with the Fed Funds Rate

Percent

Since 2000, the lines for money market yield and fed funds effective rate have been on top of each other.

Historical analysis does not guarantee future results.
Through December 31, 2023
Source: Bloomberg

The erosion of yield and potential return can be both immediate and dramatic, as the Fed tends to ease quickly. For example, in September 2007, investors who allocated to cash before the Fed started its easing cycle expected to earn a 4.7% yield over the following 12 months, given starting cash yield levels. Instead, because rates fell, they realized a yield of just 2.7%.

Today’s cash investors are similarly likely to experience an erosion of yield and potential return, given consensus expectations for a meaningful decline in the fed funds rate in 2024 (Display).

Money Market Yields Are Poised to Decline from 5.3% to Under 4% in 2024

Implied Fed Funds Effective Rate (Percent)

Reflecting current market expectations, the implied fed funds effective rate declines over the year by more than 150 bps.

Current analysis and forecasts do not guarantee future results.
As of December 31, 2023
Source: Bloomberg

If Yields Rise, Asymmetry Is in Investors' Favor

For all these reasons, we believe that bonds will outperform cash over the next year, assuming the Fed eases and yields decline, as most market observers expect. But what if yields rise instead? That’s a possibility—albeit a remote one—if inflationary forces reverse direction and the Fed renews its hiking cycle. But even in the event of rising yields, bonds are comparatively well positioned, thanks to today’s high starting yields. These ample yields help cushion against potential loss when bond yields rise.

A simple theoretical exercise illustrates how yield contributes to asymmetry of returns in the bond market. Assuming a parallel shift in rates along the yield curve, a 1% decrease in yields from today’s levels suggests double-digit potential returns across much of the bond market, while a 1% increase in yields—an unlikely scenario—suggests modestly negative returns at worst (Display).

Today’s High Starting Yields Help Mitigate Potential Downside for Bonds

Simplified Scenario Analysis: 12-Month Potential Return (Percent)

Display 5 title A simplified analysis shows returns between 11.2–12.5% if rates fall 1% and returns between -3.6 and +5.1% if rates rise 1%.

For illustrative purposes only. Current analysis does not guarantee future results.
Simplified analysis assumes current starting yields and durations of indices shown and parallel shifts along the US Treasury yield curve. Indices: Bloomberg US Treasury Bellwethers: 10-Year; Bloomberg US Aggregate Bond Index; Bloomberg US Corporate Investment Grade Index; Bloomberg US Corporate High Yield Index; and Bloomberg US Aggregate Securitized—MBS
As of December 31, 2023
Source: Bloomberg, J.P. Morgan, US Federal Reserve Board and AB

Work Against the Clock

Investors can expect continued volatility as yields trend lower over the next few months. However, given a likely surge in demand for bonds and expected erosion of cash yields, we think that those who invest in bonds now are well positioned for potential returns.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to revision over time.

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