The Start of Fed Rate Cuts: Challenges and Opportunities for Liquidity-Minded Investors
As the Fed contemplates rate cuts, investors may face new considerations for managing liquidity and returns.
- Portfolio Construction
- Fixed Income Insights
- Markets & Economy
- Cash
Key Points
What it is
We explore the potential impacts of expected rate cuts, focusing on how they may affect liquidity management strategies for investors.
Why it matters
With rate cuts potentially leading to declining yields, liquidity-minded investors may choose to assess their cash holdings and short-term investments.
Where it's going
Broad market trends suggest a shift toward diversified liquidity strategies and a reevaluation of ultra-short fixed-income options, reflecting expectations of ongoing Fed rate cuts.
The market is currently pricing in a Fed rate cut on September 18. We anticipate a 25- cut. With inflation closing in on the Fed’s 2 percent target and the labor market still healthy, the start of the rate-cutting cycle will likely be good news for the U.S. economy. Now, rate cuts may pose challenges to liquidity-minded investors, but there are ways to potentially mitigate the effect of declining yields on one’s cash reserves. Let’s take a closer look.
In recent years, with money market yields elevated and the yield curve inverted, the perceived cost of holding excess liquidity may have seemed relatively low. If economic conditions evolve broadly as we anticipate, however, shorter-term yields will likely fall significantly, and the curve will likely dis-invert. So now would be a good time for the size and composition of their cash reserves.
Let’s look first at the composition of cash reserves. Direct holdings of money market instruments—such as —that are not sufficiently diversified across the maturity spectrum may be subject to abrupt declines in yields when the Fed begins cutting rates. In contrast, a well-diversified money market fund that is invested in a wide range of maturities may help ease the sting of declining yields.
History suggests that, when the Fed starts cutting rates, investors potentially benefit from moving a portion of their cash not already earmarked for short-term or operational needs to fixed-income strategies. These strategies add only limited exposure to interest-rate risk because they typically focus on bonds maturing in three years or less. And they potentially generate favorable risk-adjusted returns by including holdings of high-quality short-term corporate bonds and asset-backed securities.
One last point before we close: While we agree with the market on the timing of the first Fed rate cut, we believe economic conditions may warrant a more gradual pace of rate cuts than currently priced in. For instance, unlike the market, we view the bar for a 50-basis-point cut this month as very high. More generally, the effects of cuts on the front end of the curve may not be as pronounced as the market currently anticipates. But this is a topic for another day.
A basis point is 1/100th of 1%, or 0.01%. Basis points often are used to quantify interest rates, bond yields and investment returns.
Funds that invests in securities with very short durations or maturities.
A Treasury bill is a loan to the U.S. government that matures in three, six or 12 months.
Main Point
Navigating Fed Rate Changes: Considerations for Liquidity-Minded Investors
As the Fed considers cutting rates, liquidity-minded investors may want to consider diversifying maturities and reassessing cash reserves to navigate the potential challenges of falling yields.
Antulio N. Bomfim
Head of Global Macro – Global Fixed Income
Antulio Bomfim, head of global macro for the global fixed income team, oversees interest rate strategy, systematic volatility, liquidity and monitoring of systemic risk globally. He is also responsible for the firm’s global liquidity management business.
Read BioContact Us
Interested in learning more about our expertise and how we can help?
IMPORTANT INFORMATION
Northern Trust Asset Management (NTAM) is composed of Northern Trust Investments, Inc., Northern Trust Global Investments Limited, Northern Trust Fund Managers (Ireland) Limited, Northern Trust Global Investments Japan, K.K., NT Global Advisors, Inc., 50 South Capital Advisors, LLC, Northern Trust Asset Management Australia Pty Ltd, and investment personnel of The Northern Trust Company of Hong Kong Limited and The Northern Trust Company.
Issued in the United Kingdom by Northern Trust Global Investments Limited, issued in the European Economic Association (“EEA”) by Northern Trust Fund Managers (Ireland) Limited, issued in Australia by Northern Trust Asset Management (Australia) Limited (ACN 648 476 019) which holds an Australian Financial Services Licence (License Number: 529895) and is regulated by the Australian Securities and Investments Commission (ASIC), and issued in Hong Kong by The Northern Trust Company of Hong Kong Limited which is regulated by the Hong Kong Securities and Futures Commission.
For Asia-Pacific (APAC) and Europe, Middle East and Africa (EMEA) markets, this information is directed to institutional, professional and wholesale clients or investors only and should not be relied upon by retail clients or investors. This document may not be edited, altered, revised, paraphrased, or otherwise modified without the prior written permission of NTAM. The information is not intended for distribution or use by any person in any jurisdiction where such distribution would be contrary to local law or regulation. NTAM may have positions in and may effect transactions in the markets, contracts and related investments different than described in this information. This information is obtained from sources believed to be reliable, its accuracy and completeness are not guaranteed, and is subject to change. Information does not constitute a recommendation of any investment strategy, is not intended as investment advice and does not take into account all the circumstances of each investor.
This report is provided for informational purposes only and is not intended to be, and should not be construed as, an offer, solicitation or recommendation with respect to any transaction and should not be treated as legal advice, investment advice or tax advice. Recipients should not rely upon this information as a substitute for obtaining specific legal or tax advice from their own professional legal or tax advisors. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. Indices and trademarks are the property of their respective owners. Information is subject to change based on market or other conditions.
All securities investing and trading activities risk the loss of capital. Each portfolio is subject to substantial risks including market risks, strategy risks, advisor risk, and risks with respect to its investment in other structures. There can be no assurance that any portfolio investment objectives will be achieved, or that any investment will achieve profits or avoid incurring substantial losses. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Risk controls and models do not promise any level of performance or guarantee against loss of principal. Any discussion of risk management is intended to describe NTAM’s efforts to monitor and manage risk but does not imply low risk.
Past performance is not a guarantee of future results. Performance returns and the principal value of an investment will fluctuate. Performance returns contained herein are subject to revision by NTAM. Comparative indices shown are provided as an indication of the performance of a particular segment of the capital markets and/or alternative strategies in general. Index performance returns do not reflect any management fees, transaction costs or expenses. It is not possible to invest directly in any index. Net performance returns are reduced by investment management fees and other expenses relating to the management of the account. Gross performance returns contained herein include reinvestment of dividends and other earnings, transaction costs, and all fees and expenses other than investment management fees, unless indicated otherwise. For U.S. NTI prospects or clients, please refer to Part 2a of the Form ADV or consult an NTI representative for additional information on fees.
Forward-looking statements and assumptions are NTAM’s current estimates or expectations of future events or future results based upon proprietary research and should not be construed as an estimate or promise of results that a portfolio may achieve. Actual results could differ materially from the results indicated by this information.
Not FDIC insured | May lose value | No bank guarantee