High interest rates have been a boon to Americans holding cash, but many on Wall Street are cautioning investors to start thinking ahead. People have been piling into cash vehicles, such as money market funds and certificates of deposit, since the Federal Reserve started hiking interest rates. Total money market fund assets hit a record $6.12 trillion for the week that ended on Wednesday, according to the Investment Company Institute . Interest rates appear to be staying higher for longer, with the Federal Reserve on Wednesday projecting only one rate cut this year. Investors may be tempted to stay in short-term instruments to collect higher yields — the Crane 100 Money Fund Index has an annualized seven-day yield of 5.12% — but staying there presents reinvestment risk. “If short-term yields fall in the future, which is likely with Fed rate cuts on the horizon, then those 5%-plus yields will not be available when it’s time to reinvest the funds,” said Kathy Jones, chief fixed-income strategist at the Schwab Center for Financial Research, in her mid-year fixed income outlook last week. Instead, investors looking to lock in yields above 5% for a longer period can choose investment-grade corporate bonds or government agency mortgage-backed securities, or MBS, she added. Agency MBS have a duration of about six years, per the Bloomberg US MBS Index as of June 3, Jones noted. Duration is a measure of a bond’s price sensitivity to fluctuations in interest rates. Bonds with greater duration also tend to have longer-dated maturities. Further, the coupon yield on agency MBS is at roughly 5.7%, a level that is “attractive for such a high-quality, liquid sector,” according to Leslie Falconio, head of taxable fixed-income strategy in UBS Americas’ chief investment office. Turning to residential mortgages for yield Agency MBS are part of the overall residential mortgage-backed securities, or RMBS, sector. RMBS are debt obligations created out of a pool of mortgages, and their cash flows are tied to the interest and payments on those loans. Agency MBS are backed by the government and issued by agencies Fannie Mae, Freddie Mac and Ginnie Mae. Wells Fargo also thinks it’s time to start moving money out of cash by dollar cost averaging — or adding exposure over time — into some longer duration assets, said Luis Alvarado, global fixed-income strategist at Wells Fargo Investment Institute. Right now, the residential mortgage-backed securities sector looks attractive because of its relative value compared to investment-grade corporate bonds, he said. The firm recently upgraded the securitized sector, including RMBS, to favorable from neutral and downgraded Treasurys to neutral from favorable. Investors can gain exposure to MBS through exchange-traded funds. Alvarado specifically likes high quality within RMBS, including agency and non-agency mortgages. While supply is expected to remain flat, he expects demand to grow from banks as their loan growth decreases. “We believe mortgages (RMBS) are going to be a great recipient of flows because they still provide you with high credit quality, plenty of liquidity and a relative advantage to IG corporates, especially on spread differentials,” he said. UBS also likes agency mortgage-backed securities right now. The interest rate volatility of the past year has weighed on the sector, causing it to lag its corporate counterparts, said Falconio. That has led to them being cheap compared with BBB corporate bonds, she noted. UBS America’s chief investment office is anticipating a soft landing and two Federal Reserve rate cuts this year, but Falconio said it doesn’t necessarily matter whether it is one or two. “We just need for them to a) cut this year and b) ensure that the probability of a hike is pretty much off the table — and it is,” she said. Agency MBS are also AAA-rated, she pointed out. “That asset class will do very well going forward,” Falconio said. “Corporates [spreads] are tight … it’s a high quality asset class that you’re earning 5.7[%] yield, and the spreads are almost one standard deviation cheap for the current coupon,” she added. “And we’re at the part of the cycle where the Fed is going to start to pivot to a cut — and that’s going to help the sector as well.”
This sector is loved by Wall Street for its attractive yields and relative value
