What to keep in mind about high short-term rates

In normal markets, the yield curve (a line chart showing yields of Treasuries at various maturities) is upward sloping, meaning long-term interest rates are higher than short-term rates. The yield curve is currently inverted and an investor is getting far more yield investing in short bonds than those with longer maturities. The 5.21% yield on the 3-month Treasury (T-bill) is at a level we haven’t seen in 22 years.¹ Meanwhile, a 30-year T-Note is yielding 3.82%.²

While it’s nice to get attractive yields without much duration risk (sensitivity to interest rate changes), knowing what the yield curve could look like in the future can help bond investors. The implied yield, the difference between the current 3-month T- bill rate and where it could be in 18 months (derived from the forwards market), is an indicator of future rates (see chart below). The current spread of -1.95% shows that 18 months from now, the 3-month T-bill is expected to be priced nearly 2% lower than it currently is.³

With short-term rates the highest in decades, it’s tempting to keep a large allocation to cash equivalents like T-bills. However, that introduces reinvestment risk —the probability of not being able to reinvest this money at the same rate. In our opinion, the best way to minimize this risk is to begin to move from T-bills into more traditional bonds such as corporates. For instance, since 2008, the monthly return on corporates bonds has outperformed T-bills by 425 basis points on average (see chart below).⁴ Investors, of course, won’t be able to time the market perfectly when doing this. But it will, at least, minimize the risk of having to invest in 3-month T-bills at a lower rate when the yield curve returns to normal and short-term rates are lower than long-term rates.