skip navigation

Stay up to date on timely topics and market events. Subscribe to our Blog now.

06 December 2023

Short-Maturity Credit—There’s Still Time to Lock in Attractive Yields

By James J. So, CFA

Stay up to date on timely topics and market events. Subscribe to our Blog now.

Are We at a Turning Point for Monetary Policy?

To combat inflation, monetary policy has been on a tightening upswing over the last couple of years. After the fastest and steepest pace of rates hikes in history, an inverted yield curve has done its job by attracting capital into cash (Exhibit 1) and away from investments further out the risk spectrum. If monetary policy is now at a turning point as markets believe, could this be an opportune time to take a step out the risk spectrum and lock in those higher yields?

Exhibit 1: Assets Flowed Into Cash—MMF Balances Approach $6 Trillion
Explore Assets Flowed Into Cash—Money Market Fund Balances Approach $6 Trillion
Source: Board of Governors of the Federal Reserve System (US). As of 30 Jun 23. Select the image to expand the view.

Inflation is on the decline and clearly approaching the Fed’s comfort zone, while at the same time the US economy is projected to cool from Q3’s blistering pace. As a result, over the past few weeks market expectations for Fed policy have shifted from pricing in the chance of another hike in 2023 to now bringing forward expectations of a rate cut in 2024 by a few months (Exhibit 2).

Exhibit 2: Market Pricing Implies 100+ bps of Cuts in 2024
Explore Market Pricing Implies 100+ bps of Cuts in 2024
Source: Bloomberg. As of 29 Nov 23. Select the image to expand the view.

Recent history suggests market expectations may be in in the right vicinity. Monetary policy works with long and variable lags but eventually hiking cycles have almost always led to a recession (the ’94-’95 experience being the lone exception). When looking at the last three rate hike cycles, the average time the Fed has been able to maintain its highest level of policy rates has been around nine months (Exhibit 3). The last fed funds rate hike was in late July 2023 and moving nine months out from then would put us in the spring of 2024. Should market expectations play out and the Fed begin to cut policy rates sometime next year, the attractive ultra-short yields currently enjoyed by money market fund (MMF) investors will begin to dissipate.

Exhibit 3: How Long Will Short Rates Stay High?
Explore How Long Will Short Rates Stay High?
Source: Board of Governors of the Federal Reserve System (US). As of 01 Oct 23. Select the image to expand the view.

Locking in Attractive Yields

Money market fund yields will fall if and when the Fed cuts again, but investors can lock in attractive yields for at least a little while longer by taking two small steps out the risk spectrum into short-maturity high-quality corporate bonds. When compared to cash the first step out is on the maturity spectrum. Corporate bond yields in general are back to levels not seen since the immediate aftermath of the global financial crisis but the inverted Treasury yield curve has allowed short (1- to 3-year maturity) corporate yields to now rival those of longer-dated bonds (Exhibit 4) with a fraction of the interest-rate risk.

Exhibit 4: Inverted Treasury Yield Curve Has Led to a Flat Credit Curve
Explore Inverted Treasury Yield Curve Has Led to a Flat Credit Curve
Source: Bloomberg. As of 30 Nov 23. Select the image to expand the view.

The other step out is from a fundamental credit perspective. While investment-grade corporate bonds do carry more credit risk than money market funds, the overall sector has remained resilient. Balance sheets are solid and coming off a strong starting point as corporate managements in general have remained relatively conservative in Covid’s aftermath given the overabundance of macro crosswinds. Like homeowners who refinanced their mortgages a couple of years back, corporate managements also used the low-rate environment of the Covid era to issue low coupon debt and better term out their debt profiles. The sector has little debt that needs to be refinanced over the next couple of years—in fact, less than 10% of the debt stack of the Bloomberg US Corporate index matures before the end of 2025. Consequently, rising interest expense is not an immediate concern for these investment-grade companies.

From an income-statement perspective, top-line sales have remained positive as firms were able to pass on inflationary pressures to consumers. The widely expected earnings recession of 2023 never materialized. Overall economic growth is expected to decelerate, but we believe that investment-grade companies are well positioned to weather a slowdown.

As the old saying goes, timing is everything. It may be impossible to know the very best moment to move away from cash, but after being painfully repriced over the last two years, fixed-income yields are now attractive up and down the maturity and quality spectrum. As an example of the opportunities available, the Bloomberg US Corporate 1-3 Year Index (corporate bonds with maturities between 1 and 3 years) was yielding 5.57% as of November 30, 2023. This is an additional 17 bps versus the 5.40% currently offered by 3-month Treasury bills—the differential was more than 50 bps in late-November just days before Fed Governor Waller’s “Something Appears to Be Giving” speech on November 28, comments that the market took as a dovish pivot from this widely regarded hawk—and almost 90 bps more than the 4.70% yield on a 2-year Treasury STRIP. The 2-year Treasury STRIP is a rough proxy for annualized returns of the risk-free asset over the next two years (as this STRIP yield incorporates market-implied future rates moves). With monetary policy widely expected to break from its tightening bias, now may be an opportune time to lock in attractive yields without incurring much more risk.

© Western Asset Management Company, LLC 2024. The information contained in these materials ("the materials") is intended for the exclusive use of the designated recipient ("the recipient"). This information is proprietary and confidential and may contain commercially sensitive information, and may not be copied, reproduced or republished, in whole or in part, without the prior written consent of Western Asset Management Company ("Western Asset").
Past performance does not predict future returns. These materials should not be deemed to be a prediction or projection of future performance. These materials are intended for investment professionals including professional clients, eligible counterparties, and qualified investors only.
These materials have been produced for illustrative and informational purposes only. These materials contain Western Asset's opinions and beliefs as of the date designated on the materials; these views are subject to change and may not reflect real-time market developments and investment views.
Third party data may be used throughout the materials, and this data is believed to be accurate to the best of Western Asset's knowledge at the time of publication, but cannot be guaranteed. These materials may also contain strategy or product awards or rankings from independent third parties or industry publications which are based on unbiased quantitative and/or qualitative information determined independently by each third party or publication. In some cases, Western Asset may subscribe to these third party's standard industry services or publications. These standard subscriptions and services are available to all asset managers and do not influence rankings or awards in any way.
Investment strategies or products discussed herein may involve a high degree of risk, including the loss of some or all capital. Investments in any products or strategies described in these materials may be volatile, and investors should have the financial ability and willingness to accept such risks.
Unless otherwise noted, investment performance contained in these materials is reflective of a strategy composite. All other strategy data and information included in these materials reflects a representative portfolio which is an account in the composite that Western Asset believes most closely reflects the current portfolio management style of the strategy. Performance is not a consideration in the selection of the representative portfolio. The characteristics of the representative portfolio shown may differ from other accounts in the composite. Information regarding the representative portfolio and the other accounts in the composite are available upon request. Statements in these materials should not be considered investment advice. References, either general or specific, to securities and/or issuers in the materials are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendation to purchase or sell such securities. Employees and/or clients of Western Asset may have a position in the securities or issuers mentioned.
These materials are not intended to provide, and should not be relied on for, accounting, legal, tax, investment or other advice. The recipient should consult its own counsel, accountant, investment, tax, and any other advisers for this advice, including economic risks and merits, related to making an investment with Western Asset. The recipient is responsible for observing the applicable laws and regulations of their country of residence.
Founded in 1971, Western Asset Management Company is a global fixed-income investment manager with offices in Pasadena, New York, London, Singapore, Tokyo, Melbourne, São Paulo, Hong Kong, and Zürich. Western Asset is a wholly owned subsidiary of Franklin Resources, Inc. but operates autonomously. Western Asset is comprised of six legal entities across the globe, each with distinct regional registrations: Western Asset Management Company, LLC, a registered Investment Adviser with the Securities and Exchange Commission; Western Asset Management Company Distribuidora de Títulos e Valores Mobiliários Limitada is authorized and regulated by Comissão de Valores Mobiliários and Brazilian Central Bank; Western Asset Management Company Pty Ltd ABN 41 117 767 923 is the holder of the Australian Financial Services License 303160; Western Asset Management Company Pte. Ltd. Co. Reg. No. 200007692R is a holder of a Capital Markets Services License for fund management and regulated by the Monetary Authority of Singapore; Western Asset Management Company Ltd, a registered Financial Instruments Business Operator and regulated by the Financial Services Agency of Japan; and Western Asset Management Company Limited is authorised and regulated by the Financial Conduct Authority ("FCA") (FRN 145930). This communication is intended for distribution to Professional Clients only if deemed to be a financial promotion in the UK as defined by the FCA. This communication may also be intended for certain EEA countries where Western Asset has been granted permission to do so. For the current list of the approved EEA countries please contact Western Asset at +44 (0)20 7422 3000.