(Bloomberg) — The latest increases in US bond yields — ahead of an expected third interest-rate cut by the Federal Reserve on Wednesday — are also increasing the cost of remaining in cash and equivalents.
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Treasury bill yields — which track the Fed’s expected policy path — have fallen steadily in recent weeks, with the three-month tenor paying less than the 10-year note for the first time since 2022.
More recently, the average yield for the Bloomberg US Aggregate Bond Index — a benchmark for many fund managers — has exceeded the 4.75% high end of the Fed’s target range for the US overnight interest rate. Policymakers are expected to lower the band to 4.25%-4.5% in an announcement Wednesday afternoon — and possibly to suggest that a pause is in order for January.
“The challenge is that the recent data’s been relatively strong and there’s no obvious need to cut,” said Brendan Murphy, head of fixed income, North America at Insight Investment.
Yields have been driven higher by resilient economic data that supports the case for fewer central-bank rate cuts next year. Also, bond investors are alarmed by the potential for tax policies advocated by President-elect Donald Trump — who takes office next month — to fuel both growth and inflation.
Assuming a quarter-point rate cut on Wednesday that would leave rates down a percentage point from their peak, swap contracts that predict Fed rate decisions are priced for only a half point of easing during 2025.
Treasury yields retreated from their highest levels of the month Tuesday after mixed November retail sales data. The market’s recovery trimmed the yield for a $13 billion auction of 20-year bonds to 4.686%. While the result was higher than the indicated level of 4.671%, suggesting investors lost some interest as yields declined, the expected yield peaked earlier in the session near 4.72%.
Bond fund managers have struggled to compete with money-market funds offering higher yields since the Fed raised rates by a cumulative five percentage points in the past two years.
Cash in money market funds reached a record $6.77 trillion in recent weeks, from less than $6 trillion in April.
As the Fed cuts rates, cash equivalents will “rapidly and repeatedly turn over into lower-yielding versions of themselves,” Richard Clarida and Mohit Mittal of Pimco, among the largest managers of bond funds, wrote in a note published Tuesday.
