Why investors are turning to 3-month Treasury bills and other cash assets over the hunt for yield

Nicholas Spiro says having suffered heavy losses in emerging markets, global equities and US corporate bonds, investors are turning to money market instruments

Nicholas Spiro

Published: 2:00pm, 29 Nov 2018

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One of the big trends in financial markets since the 2008 financial crisis has been the “reach for yield” by income-starved investors. Years of aggressive quantitative easing by the world’s leading central banks caused yields on benchmark government bonds to fall to pitifully low levels. By August 2016, the pool of sovereign and corporate debt trading with a yield below zero had reached almost US$13.5 trillion, amounting to nearly a third of the global stock of bonds, according to data from Fitch Ratings, a credit-rating agency.

The fierce compression in yields forced investors to move higher up the risk curve to generate decent returns. Last year, emerging markets, junk bonds, equities and ultra-long-dated government debt were among the main beneficiaries of the hunt for yield.

Yet, since the beginning of this year, the appeal of risk assets has diminished significantly. In February, a surge in volatility in US stocks put an end to a long period of calm in markets, causing the lofty valuations of American shares to come under scrutiny. The turbulence erupted just as global growth was becoming less synchronised and facing mounting threats, stemming mainly from the escalation in trade tensions. A brutal sell-off in developing economies, triggered by a rally in the US dollar, dented investors’ risk appetite further.

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Another important reason why the scramble for yield has dwindled is this year’s dramatic change in the fixed income landscape. For the first time since the financial crisis, the yield on 3-month US Treasury bills – risk-free and ultra-liquid securities that are the markets’ closest proxy for hard cash – has risen above most of the main gauges of inflation. Since the start of this year, the yield has shot up 100 basis points to just below 2.4 per cent, its highest level since January 2008 and above America’s core inflation rate and the Federal Reserve’s own preferred measure of inflation.

Shoppers make their way through a mall in Scranton, Pennsylvania, on November 23. For the first time since the financial crisis, the yield on 3-month US Treasury bills has risen above most of the main gauges of inflation. Photo: AP

What is more, the 3-month Treasury yield is also higher than the average 12-month dividend yield on the S&P 500 equity index – which currently stands just below 2 per cent – for the first time in a decade. This means that investors, who sought out risk assets in the post-crisis years because of the meagre returns offered by short-term debt, can now get a positive real return from super-safe Treasury bills.

Make no mistake, cash is no longer trash. The catalysts for the jump in Treasury yields are the Fed’s hawkish monetary policies – the US central bank is widely expected to raise interest rates next month for the fourth time this year – and the surge in US debt issuance to pay for tax cuts enacted last year.

Investors may expect the Fed to blink. It won’t

The implications of cash becoming a viable alternative to other asset classes at a time of acute uncertainty in markets and the global economy are already clear. According to a report published by JPMorgan last Friday, 3-month Treasury bills are one of the few asset classes, together with the dollar, to have generated positive returns this year as investors retreat from a growing number of vulnerable assets and sectors, notably emerging markets and, more recently, technology stocks.

The growing allure of cash is accentuated by the recent sell-off in US corporate bonds – the part of the market that until recently was the most resilient to the tightening in financial conditions but is now the focal point of anxiety.

A man checks his smartphone while standing in front of an Apple store in Shanghai on November 27. Apple has lost a fifth of its value in a tech market rout since October. Photo: Bloomberg

Spreads, or the risk premium, on American investment grade and high-yield (or “junk”) bonds have risen sharply since early October due to growing concerns about the impact of rising rates and the plunge in oil prices. In the past month alone, spreads on US junk bonds have increased 60 basis points, according to data from JPMorgan. Corporate debt is expected to be the worst performing asset class next year, according to the results of Bank of America Merrill Lynch’s latest fund manager survey.

Corporate debt is expected to be the worst performing asset class next year

After having suffered heavy losses in emerging markets, global equities and now US corporate bonds, many investors are choosing to play it safe and increasing their exposure to cash, putting risk assets under more strain.

Does this mean that the hunt for yield has more or less run its course? Not necessarily. Yields on short-term government debt in the euro zone and Japan remain in negative territory, providing a strong incentive for investors to continue seeking out higher-yielding opportunities in other asset classes. Moreover, some investors believe market conditions will improve next year, particularly in emerging markets which were oversold to begin with.

Still, cash is increasingly competitive, especially with equity markets remaining volatile. For risk-averse investors, a positive real return from an ultra-safe 3-month Treasury bill is not a bad proposition as an awful year in markets draws to a close.

Nicholas Spiro is a partner at Lauressa Advisory

This article appeared in the South China Morning Post print edition as: Cash is back as three-month Treasury bills lure investors

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