US government money market funds are continuing to see record inflows this year due to their high yields and lower-risk status, making them an attractive option for investors. However, we believe that intermediate high-quality bonds may provide a compelling alternative for longer-term portfolio allocations.
Firstly, the Bloomberg US Aggregate Index (Aggregate Index) is currently offering a 16-year high yield, making it an attractive entry point for investors looking for potential total return. On the other hand, money market funds do not offer the same long-term return predictability due to short-term interest rate fluctuations. Furthermore, if the US Federal Reserve cuts short-term interest rates sooner than expected, money market yields and total returns could be compromised. Therefore, longer-duration bonds may offer stronger long-term value.
In addition, high-quality bonds have historically outperformed in falling interest rate environments, benefiting from their longer duration profile. This has been evident in the past when the Fed has cut interest rates quickly and sharply, leading to outperformance of the Aggregate Index in comparison to cash. Thus, the duration of intermediate bonds offers potential benefits in such environments.
Moreover, high-quality bonds have shown a negative return correlation with equities, making them a valuable diversifier in portfolio construction. Despite a reversal of this trend in 2022, we believe that as the Fed nears its terminal rate, high-quality bonds are well positioned to reassume their traditional role as a portfolio “diversifier.”
Looking ahead, with higher yields and income, the classic 60/40 equity/bond allocation could become the dominant target for investors once again. This presents an opportunity for investors to consider historically elevated yield options across the entire yield curve, with intermediate bonds providing a compelling alternative for potential benefits from elevated income, total return, and portfolio diversification.
In conclusion, while the Fed’s ultimate short-term interest rate path is somewhat uncertain, it may be beneficial for investors to extend the duration of their fixed-income exposures. With the US government money market funds and intermediate high-quality bonds both offering their own set of advantages, investors should consider the potential benefits of each in the current market environment.
