Ultra-Short Bonds May Be Better Bets Than Cash

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FUSI

Treasury yields are uncomfortably high and there’s still plenty of talk that, due to high inflation, the Federal Reserve will have to raise interest rates once more over the near term.In theory, that sounds like a great setup for cash instruments, including CDs and money markets. However, some experts argue that ultra-short bonds and ETFs, such as the American Century Ultrashort Income ETF FUSI, may be the preferred options for investors who want to take advantage of high interest rates in low-risk fashion. As American Century’s Yulia Kosiw points out, inflation and taxes are points to consider, and potential headwinds to holding too much cash. “Taxes can further reduce that income, while inflation can diminish its purchasing power. Interest from many cash equivalents is typically taxed as ordinary income, although tax treatment varies by investment and investor,” she noted. “At the same time, persistent inflation increases the cost of everyday expenses, gradually reducing what those cash holdings can buy.”Short Duration, Not Short On IncomeThe actively managed FUSI attempts to beat the Bloomberg U.S. 1-3 Month Treasury Bill Index, which is to say duration isn’t an issue with this ETF. The fund’s option-adjusted duration is just 0.34 years, but even with that reduced sensitivity to interest rate changes, FUSI may be the better income-generating idea than high-yield cash alternatives. “Ultrashort-maturity bonds may offer higher income potential than cash equivalents, although their values can fluctuate and they carry additional risks,” added Kosiw. “Because their maturities and durations are typically short, they may be less sensitive to interest-rate changes than longer-maturity bonds.” FUSI, which carries a five-star rating from Morningstar, may prove useful to advisors and investors in other ways, including the point that cash-equivalent yields may stay low for an extended period. Using history as a guide, cash yields rise in tandem with interest rates, but when the Fed pauses its tightening cycles, cash yields can and do fall. That’s something to keep in mind over the near term because the prevailing wisdom indicates that the central bank could hike rates once more, but it’s unlikely to traverse a tightening regime comparable to what was seen in 2022. “If interest rates remain near current levels, cash equivalents may continue to generate less income than they did in recent years,” said Kosiw. “Cash-equivalent yields may change little in the near term. Although the Fed has shifted to a tightening bias, we don’t believe this marks the start of an extended rate-hike cycle.” For more news, information, and analysis, visit the Core Strategies Content Hub.

Ultra-Short Bonds May Be Better Bets Than Cash

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