Since 2022, short-term government debt, specifically Treasury bills (T-bills), have become increasingly appealing to investors. In fact, T-bills have been offering yields of over 5%. This positive momentum was driven by the Federal Reserve’s tighter monetary policy, which led to a significant rise in interest rates. 

When we talk about T-bills, we are referring to short-term loans that investors provide to the U.S. government. These loans have maturity periods ranging from a few weeks to a year, and they are considered one of the safest investments available because they are backed by the full faith and credit of the U.S. government. The main goal is to profit from the yields, which are the returns earned from the difference between the purchase price and the face value received at maturity.  For example, if you buy a Treasury bill with a face value of $1,000 for $950 and it matures in a year, you will receive $1,000 at maturity. This means you made $50 from your $950 investment, which is a gain of about 5.26%. (To find the interest rate, divide the interest earned by the purchase price: $50 / $950 ≈ 5.26% – effective interest rate on your T-bill).

As interest rates increased and remained high for the last two and a half years, T-bills became a popular choice for investors, leading to a large amount of money flowing into funds that hold them. As stated above, they offer a combination of good returns and low risk, and with rates at such high levels, T-bills have surged to new highs. 

However, the appeal of T-bills may soon diminish due to the latest economic data, which makes it almost certain that the Fed will begin easing its monetary policy at the September meeting. Notably, with today’s inflation report showing lower-than-expected numbers, a rate cut by the Fed now seems inevitable!

Normally, short-term investments like T-bills decrease in value when interest rates are cut because their yields are closely tied to current interest rates. When the Federal Reserve lowers interest rates, new T-bills are issued with lower yields. As a result, existing T-bills with higher yields become less attractive to investors. To adjust for this, the prices of existing T-bills fall so that their yields align with the new, lower rates in the market. Consequently, when interest rates are reduced, the returns on existing T-bills drop, leading to a decrease in their value.

In addition, it is worth noting that historically, T-bills have underperformed compared to long-term bonds when rates fall, as longer-duration bonds tend to offer better returns in a declining interest rate environment.

With the possibility of interest rates dropping, T-bills could soon lose their shine, and if you are holding these short-term investments, it might be time to rethink your strategy. Keep in mind that, as stated by JPMorgan, yields can fall significantly. For example, the three-month T-bill rate could slip from 5.4% to about 3.5% over the next 18 months, and if the economy slows more than expected, this drop could be even steeper.