Two years ago, many investors found comfort in elevated cash yields after the difficult bond market environment of 2021–22. At the time, the prevailing view was that interest rates would remain “higher for longer”. We argued that while cash was attractive in the near term, its appeal would likely diminish as economic growth moderated and inflation moved closer to the Federal Reserve’s (Fed’s) 2% target, allowing the Fed to eventually begin easing monetary policy. For investors willing to extend maturities, intermediate-term bonds offered the opportunity to lock in attractive yields before that transition occurred.
In hindsight, that perspective proved largely correct. After enduring the highest bout of inflation since the 1980s and the Fed’s aggressive tightening campaign, intermediate-term bonds have delivered solid returns over the past two years, generating approximately 11.5%. As expected, yields on cash declined as the Fed lowered rates from their peak levels.
However, trade policy uncertainty, persistent inflation pressures, and higher energy prices have complicated the economic outlook and limited the Fed’s ability to continue normalizing policy. As a result, cash yields have remained more competitive than many investors anticipated.
So, where does that leave us today?
We continue to believe that the risk/return trade-off favors intermediate-term bonds for a few key reasons:
1. Locking in Attractive Yields
While yields are below the highs reached in 2023, investment-grade intermediate-term bonds continue to offer some of the most compelling income opportunities seen in decades. Although yields could move higher if the Fed resumes tightening, they could also decline quickly if economic growth weakens or inflation continues to moderate.
Investors who extend maturities today have an opportunity to lock in attractive income levels that may not be available indefinitely.
2. Diversification Benefits
Intermediate-term bonds have historically provided stronger diversification benefits than cash during periods of equity market weakness. While cash typically preserves principal value, its yield often declines when the Fed lowers short-term rates to support economic activity.
High-quality intermediate-term bonds, in contrast, can benefit from both income generation and potential price appreciation as interest rates fall. This combination has historically made bonds a more effective counterbalance to equity risk than cash alone. Should interest rates rise, the bond’s value would fall, though today’s starting yields will offer a buffer against price declines. Bonds also carry credit risk—the risk that the issuer will be unable to make interest or principal payments.
3. Avoid Making a Rate Bet
Only a few months ago, many Fed officials expected the federal funds rate to fall to 3% or lower over the next 12 to 18 months. Today, expectations have shifted materially, with policymakers indicating that short-term rates may remain higher for longer and could even move modestly higher if inflation pressures persist.
If even the Fed—with its vast resources, economic data, and expertise—cannot confidently predict the path of interest rates it controls, investors should be cautious about positioning portfolios around a specific rate forecast. Unforeseen developments occur regularly, and market timing rarely proves successful over the long run.
The Bottom Line
Cash remains an appropriate tool for liquidity needs, emergency reserves, and near-term spending requirements. However, investors with longer-term horizons should consider whether current cash allocations remain aligned with their objectives.
Intermediate-term bonds continue to offer attractive yields, meaningful diversification benefits, and the potential for capital appreciation if economic conditions weaken. Rather than attempting to predict the next move in interest rates, we believe building a well-diversified fixed income allocation remains the more prudent course for long-term investors.