With the stock and bond markets heading lower due to uncertainty over interest rates, investors are turning to an old standby — cash.
In recent weeks, Wall Street has struggled with the possibility of more rate hikes from the Federal Reserve. Investors are worried that higher lending costs and inflation will choke off economic growth, which makes buying stocks and bonds a risky prospect.
When the market grows nervous, the “textbook response” to avoid risk is moving funds into the money market, said Brian Gendreau, investment strategist for ING Investment Management.
The money market is a part of the fixed-income market that deals with short-term debt securities — debt that comes due in less than a year. It’s a temporary safe haven for funds because the cash is readily accessible and almost guaranteed to see at least a modest return.
Money market instruments include Treasury bills, certificates of deposit and other types of short-term debt. Often these investments are managed by money market mutual funds, which generate returns primarily from yields on debt that matures in a year or less. The short term nature of the investment means that the price of money market fund shares rarely fluctuate.
Cash investments are considered a default place to tuck away funds when the going gets tough. But with the Fed poised to lift interest rates past 5 percent and the bond yield curve flattening — short-term yields are catching up with long-term rates — analysts say the low-risk money market is increasingly becoming an option to highly volatile equities.
“There’s a magic 5 percent number,” said Bruce Bent, chairman of money market fund manager The Reserve. “When rates are below 5 percent, no one pays attention. But once it gets to 5 percent, people start looking at interest-bearing accounts as an alternative investment.”
While the Fed’s string of rate hikes have boosted bond yields over the past two years, a lack of long-term confidence has narrowed the gap between short- and long-term bond yields. The current advantage of money market funds is that a short-term investment with virtually no risk can generate a similar return to holding long-term debt: The yield on the 6-month Treasury bill recently stood at 5.06 percent, for example, while the 10-year Treasury note showed a yield of 5.02 percent.
“Cash is attractive right now,” Gendreau said. “It’s not hard to find (certificate of deposit accounts) paying more than 5 percent with no principal risk.”
Traders will continue using money markets and other cash investments as simply a place to stow funds when stocks take a downturn, then use the money to seek bargains or attractive investments. Yet overall assets in money market mutual funds grew to a 2006 high of $2.07 billion during last month’s selloff, according to the Investment Company Institute.
With no end to the Fed’s rate tightening in sight, investors might leave more cash in money market funds to avoid volatility elsewhere. In a volatile stock market where the Dow Jones industrial average is up a mere 2.66 percent and the Standard & Poor’s 500 index has added 1.25 percent so far this year, cash will continue to come into vogue.
“With interest rates over 5 percent, (money market) will be an investment alternative instead of a default,” Bent said.