Is Your Cash A Gainer or A Loser?

Interest rates have moved off the historically low levels we saw at the start of 2021, and there are several reasons we believe they can increase more this year:

  • higher inflation expectations,
  • strong economic recovery,
  • less Federal Reserve (Fed) involvement in the bond market and
  • a record amount of Treasury issuance1.

We also see inflationary pressures building as the economy continues to recover. A bondholder’s main nemesis, inflation erodes the “real” value of principal and interest payments making them worth less. While inflation will likely not be a lasting problem, we do expect higher consumer prices in the near term, which should nudge interest rates higher throughout the rest of this year. 

Expected returns for core fixed income (as defined by the Bloomberg U.S. Aggregate Bond Index) through the remainder of the year are low to even negative in certain scenarios. Because we believe interest rates will increase from current levels, core fixed income returns may add more negative returns to already negative year-to-date returns. If core fixed income returns are negative for the year, it will be the first time since 2013, a great year for stocks but also the last time the Fed talked about reducing the size and scope of bond purchases (also known as tapering).

When we evaluate the economic and financial landscapes, the Fed is a key risk we’re keeping our eyes on. Since March 2020, the Fed has supported the economy and financial markets by purchasing $80 billion in Treasuries and $40 billion in mortgage securities and by keeping short-term interest rates near zero. As the economy continues to recover, however, the need for continued monetary support is waning. We think it is too early for the Fed to begin to increase short-term interest rates, but believe the discussion around tapering its bond-buying programs will begin soon.

Bottom Line: Increasing inflationary pressures in a low-interest-rate environment mean many investors are seeing negative real rates of return on idle cash. In other words, the yield offered on cash is less than the current and expected short-term inflation levels. Businesses sitting on cash are losing ground, and will continue to, unless their leaders are willing to make some trade-offs including principal, credit and/or interest-rate risk. Actions could include investing cash in mortgage-backed securities, municipal bonds, bank loans, emerging market debt and short-to-intermediate, investment-grade corporate bonds.

Speak to your Treasury Management banker to be referred to an investments or wealth advisor near you who will gladly discuss options and strategies to consider for your business.

Article is based on research material prepared by LPL Financial LLC. Securities and advisory services offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC). Insurance products are offered through LPL or its licensed affiliates.

To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.

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(1) Midyear Outlook 2021: Picking Up Speed, LPL Research at LPL Financial, LLC