5-year Treasurys tend to beat cash after first Fed rate cut, this chart shows

By Christine Idzelis

'What's the cash sitting there for?' says Vanguard's Chris Tidmore

For investors considering moving out of cash now that the Federal Reserve has started cutting interest rates, returns from the U.S. Treasury bond market have been historically compelling, according to Vanguard Group's investment advisory research center.

Investors shouldn't worry that they may have "missed out" by not already putting some of their cash to work in the bond market ahead of the Fed's first rate cut last week, Chris Tidmore, a senior manager in Vanguard's investment advisory research center, said in a phone interview.

"If you believe the Fed will continue to cut rates," extending duration in the bond market by investing in Treasurys historically paid off, he said, citing durations of five to 10 years.

For example, the five-year portion of the Treasury's market's yield curve has outperformed cash in 16 of the Fed's past 17 rate-cutting cycles, Vanguard found. And in six of the last seven cycles, the outperformance is more pronounced, particularly following the Fed's first rate cut.

The chart above tracks the total return of 5-year Treasurys over cash since 1953, with the orange bars representing the performance between the Fed's first rate cut and its last.

The central bank announced Sept. 18 that it was kicking off its cutting cycle with a half-percentage-point reduction of its benchmark rate to a target range of 4.75% to 5%.

The yield on the 5-year Treasury note BX:TMUBMUSD05Y was trading around 3.48% on Tuesday afternoon, according to FactSet data, at last check. Treasury rates have dropped so far this quarter, in investor anticipation of the Fed's cutting cycle.

As bond yields and prices move in opposite directions, investors may benefit from a potential rally in certain fixed-income assets - in addition to their regular interest payments - when the Fed cuts rates.

Meanwhile, the interest rates that investors get from holding cash in their portfolios will fall as the Fed lowers its benchmark rate.

"What's the cash sitting there for?" said Tidmore. While cash that's part of an emergency fund shouldn't be locked up in a bond that won't mature for years, he said individuals who are "uber wealthy," for example, may be sitting on a lot of cash that could move into Treasurys with durations of around five years.

While investors may buy Treasurys directly and get their money back when those securities mature, they also may invest in bond funds that constantly maintain a portfolio with a particular average duration, said Tidmore.

For example, the Vanguard Intermediate-Term Treasury ETF VGIT, an exchange-traded fund that tracks an index of Treasurys with maturities of three to 10 years, has an average duration of five years. The ETF has posted a total return this year of 4.6% based on Tuesday afternoon trading, according to FactSet data, at last check.

Read: 'Cash is a trap,' warns JPMorgan's David Kelly. Here's how a traditional mix of stocks and bonds may pay off.

More broadly, the investment-grade U.S. bond market is up so far in 2024, with the Vanguard Total Bond Market ETF BND gaining a total of 4.8% this year as of Tuesday afternoon.

Meanwhile, the U.S. stock market was mostly rising Tuesday afternoon, with the S&P 500 SPX on pace to potentially notch a fresh record peak, according to FactSet data at last check. The index ended Monday at an all-time high.

-Christine Idzelis

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09-24-24 1434ET

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