Fed could be the Grinch who ‘stole’ cash earning 5%. What a Powell pivot

Yields on 3-month
and 6-month
Treasury bills have been seeing yields north of 5% since March when Silicon Valley Bank’s collapse ignited fears of a broader instability in the U.S. banking sector from rapid-fire Fed rate hikes.

Six months later, the Fed, in its final meeting of the year, opted to keep its policy rate unchanged at 5.25% to 5.5%, a 22-year high, but Powell also finally signaled that enough was likely enough, and that a policy pivot to interest rate cuts was likely next year.

Importantly, the central bank chair also said he doesn’t want to make the mistake of keeping borrowing costs too high for too long. Powell’s comments helped lift the Dow Jones Industrial Average
above 37,000 for the first time ever on Wednesday, while the blue-chip index on Friday scored a third record close in a row.

“People were really shocked by Powell’s comments,” said Robert Tipp, chief investment strategist, at PGIM Fixed Income. Rather than dampen rate-cut exuberance building in markets, Powell instead opened the door to rate cuts by midyear, he said.

New York Fed President John Williams on Friday tried to temper speculation about rate cuts, but as Tipp argued, Williams also affirmed the central bank’s new “dot plot” reflecting a path to lower rates.

“Eventually, you end up with a lower fed-funds rate,” Tipp said in an interview. The risk is that cuts come suddenly, and can erase 5% yields on T-bills, money-market funds and other “cash-like” investments in the blink of an eye.

Swift pace of Fed cuts

When the Fed cut rates in the past 30 years it has been swift about it, often bringing them down quickly.

Fed rate-cutting cycles since the ’90s trace the sharp pullback also seen in 3-month T-bill rates, as shown below. They fell to about 1% from 6.5% after the early 2000 dot-com stock bust. They also dropped to almost zero from 5% in the teeth of the global financial crisis in 2008, and raced back down to a bottom during the COVID crisis in 2020.

Rates on 3-month Treasury bills dropped suddenly in past Fed rate-cutting cycles

FRED data

“I don’t think we are moving, in any way, back to a zero interest-rate world,” said Tim Horan, chief investment officer fixed income at Chilton Trust. “We are going to still be in a world where real interest rates matter.”

Burt Horan also said the market has reacted to Powell’s pivot signal by “partying on,” pointing to stocks that were back to record territory…

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