The "wolf" of the Fed rate cut is really coming. Why haven't investors kicked the habit of "lying down and winning" in US Treasury bond trades yet?

In October 2022, the new "Bond King" Jeffery Gundlach coined a term T-bill and bill to refer to a trading strategy that takes advantage of investing in US bonds in a high-interest rate environment after the Fed raises rates. A year ago, Gundlach was advocating for buying short-term bonds to enjoy a 5% yield and easily "lie down and win".

Now, as the Federal Reserve is about to lower its policy rate from a high level it has been at for over twenty years, the warning of a rate cut is looming. Once this warning becomes reality, the yield on short-term US bonds is bound to decrease. However, investors seem reluctant to give up the "addiction" to trading T-bill and bill this week, as money market funds continue to attract funds.

Data released last week by the Investment Company Institute of the Global Fund Industry showed that as of Wednesday, August 21, about $106 billion had flowed into US money market funds this month, reaching a historical high total asset size of $6.24 trillion. It is estimated that out of this $6.24 trillion, around 60% comes from companies that have been hoarding cash since the COVID-19 pandemic, with the rest coming from retail investors satisfied with slightly higher returns than bank deposits.

Media reports point out that institutions like Pimco and BlackRock, as well as fund managers on Wall Street, have repeatedly advised investors to increase their allocation to long-term bonds. In a significantly lower interest rate environment, longer-term debt will still yield decent capital gains, while investors in cash equivalents seem content to maintain the status quo. Why is this the case?

According to Kathy Jones, Chief Fixed Income Strategist at Charles Schwab, many have discussed rate cuts before, but the story of the boy who cried wolf has not come true. Therefore, many may just be waiting for the rate cut to actually happen, as sticking to cash investments logically does not make sense. If yields decline, then having over $6 trillion in money market funds would be meaningless.

Federal Reserve Chairman Powell's speech at the Jackson Hole central bank annual meeting last Friday was seen as a dovish shift, with some commentators saying that his speech dispelled all doubts about a rate cut in September. While a rate cut in September seems certain, some analysts predict that money market funds may still be attractive to investors, depending on the extent of the rate cut.

Even if the rate is only cut by 1 percentage point, the interest rate on short-term US bonds will still remain around 4%, which is still attractive. Especially considering that before the Fed initiated this tightening cycle in 2022, rates had been close to zero for many years, the yield on long-term US bonds has always been much lower than 4%. This may explain why retail investors are not in a hurry to change their positions.

Even if the Fed starts cutting rates, money market funds can still retain at least some of the cash from retail investors, as these investments can provide higher returns than keeping funds in banks, which is also attractive to institutions offering cash management services.

John Queen, a portfolio manager at Capital Group managing $2.5 trillion in assets, pointed out that this recent tightening cycle is the first time in recent years that cash has actually provided some returns, so he understands investors' preference for cash Queen recommends adopting a classic diversification strategy, investing in a combination of cash, stocks, and fixed income, regardless of how this classic strategy has recently performed.

Wall Street News mentioned last month that some analysts are concerned that once the Federal Reserve starts cutting interest rates, the demand for short-term U.S. Treasury bonds in the money market funds may decrease, leading to an increase in short-term interest rates and continued pressure on market liquidity. On the other hand, some analysts believe that in order to capture the high returns brought by the Fed's rate hikes, investors have poured a large amount of money into money markets, and these funds will remain abundant.

Teresa Ho, the head of short-term interest rates at Morgan Stanley, pointed out:

In the past three rate-cutting cycles, funds only started flowing out of money market funds towards the later stages of the Fed's rate-cutting process, and the current 4% to 5% yield remains quite attractive