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What Is Your Cash Doing For You?

We have seen that commercial from Capital One with the catchy slogan, prompting us with the question “What’s in your wallet?”  The message is clear and effective, and carries along a certain amount of humor to a very honest question. Today, as we witness the remarkable progress seen across Treasury and government bond yields, and the disappointingly lackluster interest payout by banks and institutions in savings accounts, we are asking ourselves a similar question, “what is your cash doing for you?”

As we all know from first-hand experience, the return of inflation has affected all of us as consumers, savers, and investors. What the Federal Reserve expected to be a transitory inflation impulse resulting from the end of pandemic-era disruptions proved to be price pressures that were more embedded within the global economy.

As a result, beginning a year ago, the Fed embarked on a rate-hiking campaign to tame the inflation beast. The Fed’s rapid rate hikes have driven up borrowing costs and, last year, put significant pressure on both the stock and bond markets, both of which suffered down years. The Fed’s work continues; additional rate hikes are expected, as inflation levels remain above the Fed’s target.

A difficult moment can give rise to opportunity, however, and the present situation is no exception.  The Fed’s sharp rate hikes are helping formerly yield-starved savers.  For the first time in 15 years, investors can get around 5% on short-term U.S. Treasury bills.  These yields were essentially zero at the start of 2022.  The higher yields resulting from Fed rate policy have created a genuine alternative and a competitive option for cash.

First, a quick warmup: Treasury bonds are backed by the full faith and credit of the US government. In the financial world, they are considered a risk-free asset.  Yields are a bit higher with government agency bonds. These are bonds of such agencies as Freddie Mac and Fannie Mae, and others.  Government Agency bonds do not carry the explicit full faith and credit guarantee of the Treasury, but their debt is considered highly secure.

In addition to the absolute level of Treasury and Agency rates, it is worth noting that Treasury bonds, and the bonds of some, but not all, Agencies, are exempt from state income tax. (They are fully taxable at the Federal level, however.) The state tax exemption provides a bit more after-tax yield as compared to fully taxable bank interest from savings and CD rates.

Treasuries and Agencies yield curve (as of March, 01, 2023): 

Source:  Charles Schwab’s yield curve table

The yield chart above displays annualized interest rates for Treasury and Agency debt by maturity. Despite the higher benchmark rates set by the Federal Reserve, the interest rates paid out by banks in savings accounts have barely moved.  Case in point, the average brick-and-mortar savings account paid a paltry 0.23% APY nationally, according to Bankrate’s March 1 weekly survey of institutions.  We don’t expect this disparity to close anytime soon.

The reason is simple:  banks are well-capitalized, and not needing to attract more deposits.  More than anything, the rates banks pay on deposits reflect their need for deposits, to bolster lending; with deposit levels still high after the pandemic, banks are simply not in a hurry to raise their depository rates right now.

When you buy a government bond, assuming you hold it to maturity, you will get a guaranteed rate of return.  Yields are expressed as annualized numbers.  From the table above, a 2-year Treasury would yield 5.016% per year for two years.  Government bonds are highly liquid, and can be sold at any time before maturity.  It is worth noting, however, that bonds are subject to fluctuating market values prior to their maturity date. If an investor might need bond principal before maturity, we would invest in a suitably short maturity to forestall an early sale of any bond.

For clients with excess cash looking to earn higher yields, we can help them to capitalize on the most attractive rates the market has seen in a decade and a half.  As we scan the investment markets for attractive risk/reward opportunities, we think locking in returns and safety with a combination of Treasury/Agency bond ladder in lieu of short-term bank deposits can make a lot of sense.