Capital IdeasTM
Investment insights from Capital Group
Fixed Income
Haran Karunakaran
Recent months have seen a significant change in the macro environment with inflation broadly coming down and, after a lengthy period of interest rate hiking, we are now firmly on the path towards cutting. We have already seen the Bank of England and European Central Bank reduce rates, with the US Federal Reserve expected to follow suit imminently.
Activity in the futures market suggests we could see close to 200 basis points of cutting by the Fed by the end of 2025 but, as always, these predictions are constantly changing. After a few cuts, if the US economy continues to grow — or even accelerates, as with previous soft landings — would the Fed want to risk overheating an economy that appears in reasonably good shape?
While these questions will continue, what is clear is that the Fed and many other central banks have signalled an intent to bring rates down over the next few years. Historically, these pivots in monetary policy have significantly impacted market returns and, as such, warrant a rethink of investors’ defensive allocations.
A striking asset allocation trend over the last few years has been a significant build-up of investors’ cash balances. US money market fund assets have doubled since pre-COVID days to reach more than US$6 trillion today; if term deposits and other cash alternatives are also included, the number would be even higher. And this is not just a US trend. Many other countries around the world have also seen large increases in the allocation to cash.
In the right circumstances, outsized cash allocations can serve as an effective defensive ballast in portfolios and the heightened volatility of 2022 illustrated this well. Then, equity and fixed income markets simultaneously delivered negative returns (for the first time in almost five decades) and cash stood out as the rare asset class that delivered positive returns.
But with the backdrop having changed significantly, investors should be asking themselves whether this large build-up of cash still makes sense. As inflation eases and central banks move toward rate cuts, the benefits of maintaining such high allocations to cash may be diminishing.
On the other hand, high-quality fixed income can provide that ballast, while also seeing stronger returns as bond prices rise with falling rates. In other words, this is an environment where it may make sense to shift back toward a more traditional defensive bond allocation.
Our latest insights
-
-
Asset Allocation
-
-
-
Interest Rates
RELATED INSIGHTS
-
Interest Rates
-
Fixed Income
-
Interest Rates
Hear from our investment team.
Sign up now to get industry-leading insights and timely articles delivered to your inbox.
Past results are not predictive of results in future periods. It is not possible to invest directly in an index, which is unmanaged. The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment. This information is not intended to provide investment, tax or other advice, or to be a solicitation to buy or sell any securities.
Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. All information is as at the date indicated unless otherwise stated. Some information may have been obtained from third parties, and as such the reliability of that information is not guaranteed.
Capital Group manages equity assets through three investment groups. These groups make investment and proxy voting decisions independently. Fixed income investment professionals provide fixed income research and investment management across the Capital organization; however, for securities with equity characteristics, they act solely on behalf of one of the three equity investment groups.