Opportunities in fixed income for investors moving out of cash
Income and growth attributes can help investors put cash to work.
May 2024, From the Field -
May 2024, From the Field -
With the path of cash rates somewhat uncertain, we think it is time for investors to consider redeploying into the market. But where? With bond yields close to historic highs, we believe that fixed income is an attractive asset class to put cash to work—especially for investors seeking to lock in income.
Cash has been king these past few years. The combination of market uncertainty and high short‑term interest rates has resulted in a record amount of money held in money market funds. But staying parked in cash over a medium‑ and long‑term horizon could mean missing out on capital appreciation opportunities elsewhere. Furthermore, it’s not certain where cash rates go from here. On the one hand, its possible cash rates stay high, especially if labor markets remain tight. On the other, there is a case to be made for cash rates to fall, especially in Europe and select emerging markets, where there has been more progress in bringing down inflation.
"With bond yields close to historic highs, we believe that fixed income is an attractive asset class to put cash to work…."
Against this backdrop, we believe it is a good time for investors to consider stepping out of cash and into the markets again. The current monetary policy pause may signal a good opportunity to do so—a review of past Federal Reserve policy cycles suggests it was typically beneficial for investors to deploy cash when rates peaked (see Fig. 1).
As of April 30, 2024.
Past performance is not a reliable indicator of future performance. For illustrative purposes only. This is not representative of actual investments and does not reflect any fees andexpenses associated with investing.
Indexes cannot be invested in directly. Cash is represented by the Bloomberg U.S. Treasury Bills 1–3 Month Index, and bonds isrepresented by the Bloomberg U.S. Aggregate Bond Index. Historical average performance in the6 months leading up to the last Federal Reserve rate hike, the rate pause period (between the lastrate hike and first cut), and the 6 months after the first cut. Dates used for the last rate hike of acycle are: 02/01/1995, 03/25/1997, 05/16/2000, 06/29/2006, 12/19/2018. Dates used for the firstrate cut are: 07/06/1995, 09/29/1998, 01/03/2001, 09/18/2007, 08/01/2019.
Source: Bloomberg Finance L.P. Data analysis by T. Rowe Price.
With bond yields in several sectors near multiyear highs right now, we believe fixed income is an attractive place to deploy cash. Fixed income has diverse sector options that support a range of goals and risk tolerances. It offers opportunities for both defense and capital appreciation. The fragmented nature of the asset class means that what drives one sector of the market is different than another, so there’s often a wide dispersion among sector returns. This provides flexibility to choose sectors that suit distinct needs—generating consistent income, capital appreciation, or defense against equity market volatility.
"….we believe that investors can find a solution in fixed income to mitigate risks and address their objectives."
Fixed income and equity markets have tended to move in tandem in recent years. This understandably raises questions about whether bonds can still deliver the benefits of diversification seen historically. Correlations1 between the asset classes could continue to be volatile. However, if an extreme market event or significant downturn puts major selling pressure on risk assets such as equity, we expect high‑quality government and corporate bonds to be an effective diversifier. At a minimum, they should provide longer‑term investors with potential liquidity—therefore optionality—needed to make portfolio adjustments in times of stress.
Given the volatility and uncertainty in markets in recent years, investors may be feeling apprehensive about stepping out of cash. But regardless of how they expect the market environment to evolve, we believe that investors can find a solution in fixed income to mitigate risks and address their objectives. Below, we explore three economic scenarios and the bond strategies potentially conducive to each.
As of April 30, 2024.
For illustrative purposes only. This is not to be construed to be investment advice or a recommendation to take any particular investment action.Investments involve risks, including possible loss of principal. Diversification cannot assure a profit or protect against loss in a declining market.
Source: T. Rowe Price.
Investment solution: High Income. A scenario of moderate economic growth is our base case scenario. Investors anticipating this should consider high yield strategies as the healthy macro environment will likely be supportive. The risk of a significant credit spreas2 widening is less of a concern in this environment, which should allow for potential comfortable income accumulation. Current all‑in yields available in high yield are attractive, so it’s a good time to potentially lock in high income. As of the end of March 2024, the average yield in global high yield corporate bonds was around 7.63%, much higher than the average yield of 6.39% observed in the last 10 years.3
A higher‑quality global multi‑sector bond approach is another appealing option. It can offer attractive income potential and diversified return sources. These types of solutions provide exposure to a variety of sectors, including governments and securitized, investment‑grade, and high yield corporate bonds. The broad range of sectors offers the potential to diversify sources of return and lower volatility.
Investment solution: High quality. A deterioration scenario would involve a decline in economic activity and deceleration of inflation, leading to interest rate cuts. For investors worried about this scenario, investment solutions that are higher quality can be useful, such as developed government bonds where there’s typically better liquidity than other fixed income segments. Furthermore, the significant repricing of bond yields these past few years has led to improved valuations in government bonds with yields at some of their highest levels since the global financial crisis.
Investment‑grade corporate bond strategies also offer a potential combination of high quality and consistent income. For example, the average yield in European investment‑grade corporate bonds stood at around 3.66% at the end of March—which is well above the average level of 1.46% observed in the last decade.4
Investment solution: Diversification. A stagflation scenario would involve inflation reaccelerating and economic growth slowing. This could lead to further interest rate rises and weakness in risk markets, such as equity. Such an environment can be challenging for investors. But a good way to navigate is through utilizing alternative and very active management strategies that can potentially benefit from higher volatility. In particular, investors should consider solutions that can generate income while seeking to minimize interest rate risk and mitigate against severe risk‑off events. These include flexible strategies, such as absolute return. These are typically benchmark agnostic and can cast a broader net, with the potential to invest in a wide range of geographies, sectors, and security types. However, strategies within this category can vary significantly. If an investor is seeking diversification, it’s important to choose an approach that has either low or negative correlation with key market indexes, such as the S&P 500.
Lower‑beta multi‑asset credit strategies can also work in this scenario. These offer the ability to find diverse sources of return across the broad credit market. In particular, approaches that actively manage credit and interest rate risk can help to navigate volatile environments.
The combination of election risks, the soft global growth environment, sticky inflation, and lingering geopolitical issues may be unsettling for some investors—keeping many parked in cash. But with bond yields near historic highs, it is time to consider redeploying those cash assets to potentially lock in income at these attractive levels. In today’s ever‑evolving landscape, fixed income offers a wide range of opportunities, including strategies for income, defense, or capital appreciation purposes. Choosing an approach that prioritizes quality active research is essential. This can give investors greater confidence about shifting their cash holdings to take potential advantage of the attractive all‑in yields that are available.
Kenneth A. Orchard
Head of International Fixed Income
Kenneth Orchard is head of International Fixed Income. He is portfolio manager for the Global Multi-Sector Bond and Diversified Income Bond Strategies and co-portfolio manager for the International Bond Strategy. Kenneth is a member of the Fixed Income Steering Committee, cochair of the fixed income Sector Strategy Advisory Group, and a member of the European and UK Asset Allocation Committees. He is a vice president of T. Rowe Price Group, Inc., and T. Rowe Price International Ltd.
1Correlation measures how one asset class, style or individual group may be related to another. A perfect positive correlation means that the correlation coefficient is exactly 1. This implies that as one security moves, either up or down, the other security moves in lockstep, in the same direction. A perfect negative correlation means that two assets move in opposite directions, while a zero correlation implies no relationship at all.
2Credit spreads measure the additional yield that investors demand for holding a bond with credit risk over a similar‑maturity, high‑quality government security.
3As of March 31, 2024. Yield to worst of the ICE BofA Global High Yield Index. Performance is not a reliable indicator of future performance. Source: ICE BofA. See Additional Disclosures.
4As of March 31, 2024. Yield to worst of the Bloomberg Euro Aggregate—Corporate Bond Index. Past performance is not a reliable indicator of future performance. Source: Bloomberg Finance L.P.
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Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. Fixed‑income securities are subject to credit risk, liquidity risk, call risk, and interest‑rate risk. As interest rates rise, bond prices generally fall. Investments in high‑yield bonds involve greater risk of price volatility, illiquidity, and default than higher‑rated debt securities. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. All charts and tables are shown for illustrative purposes only.
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