Why walk out of cash now?

In 2023, the Fed continued its aggressive tightening cycle, bringing the policy rate to a 20-year high. It then paused and kept rates at an elevated level with the intention to keep financial conditions tight to slow inflation. This led to an extremely volatile interest rate environment.

As we enter 2024, we expect to move to a new regime, as monetary policy evolves from holding rates to cutting rates. This is aided by rapid disinflation, and indeed data prints from recent months point to a significant fall in core PCE inflation to below 2% on an annualized basis.

While we do not expect the outsized fall in oil prices to repeat itself in 2024, we think cooling rent prices and a loosening labor market can keep core inflation on a glide path towards the Fed’s target. This could allow the Fed to cut rate in a pre-emptive fashion.

Our outlook is for the Fed to cut rates by 125bps starting from the middle of the year, bringing the Fed Funds Rate to 4.00% - 4.25% by the end of 2024. While this is not an aggressive rate cut cycle, the downward adjustment in the policy rate can help to cushion a gradual slowdown in growth, and prevent the U.S. economy from sliding into a recession.

This so called ‘soft-landing’ scenario paints a constructive backdrop for markets in general, but clients are not necessarily well-positioned to capture opportunities in this market.

Looking across our platform, clients have substantially increased cash allocations around one-fifth at the end of 2021 to around a third of their portfolios by the end of 2023.

Historically after a Fed pivot, both stocks and bonds have tended to do well while cash yields decline, which highlights the dangers of reinvestment risk.

For the fixed income investor, the rally in bonds over the last two months has been rapid, with around 100 basis points of moves down in rates across the curve. For investors, bonds still have a role to play in portfolios, both as a source of income and protection for downside risks.

However, more tactical investors may find yields too ‘fairly-valued’ at this point in the market. As such, we recommend switching out of very long-dated positions and leaning more into high-quality credit with shorter durations, where we see more value in light of still-elevated yields and less volatility.

For 2024, we are encouraging clients to step out of cash and lean more into investments. In the long-term, excess cash allocations do not help investors achieve their goals. According to our Long Term Capital Market Assumptions, stocks, bonds and alternatives will likely outperform cash this year and over the long term. A simple 60/40 portfolio is expected to deliver 7.0% per annum over the next 10 to 15 years.

After two years of tumultuous monetary policy tightening, we think opportunities are emerging across asset classes in the year ahead.