Beat the cash thief! Negative real interest rates and how to deal with them

Steven Wieting
Chief Investment Strategist and Chief Economist

Income seeking strategies to defend against the cash thief

Negative real interest rates remain a clear and present danger to the purchasing power of cash. We believe select income-seeking strategies can help defend against this threat.

Key takeaways

Amid the present uncertainty, many investors are tempted to sit on excess cash

While we expect moderating inflation and a peak in rates this year, the threat from the cash thief is set to persist

Following the rise in rates, we see potential income-seeking opportunities in various high quality bonds once more

We favor dividend grower and commodity-producer equities, for qualified investors, select capital markets and alternative strategies

The first few months of 2022 have been a tough period for many stocks and bonds. The MSCI All Country World Index has shed as much as 18%, with some US long-term government bonds suffering their worst run for decades. Among investors’ most pressing concerns is tighter monetary policy. The US bond market is currently pricing in one of history’s largest rate increases over the next two years – figure 1.

Figure 1. US bond investors expect record Fed tightening
Chart shows US Treasury 2-yr note less Fed policy rate. Source: Haver Analytics and Bloomberg as of Apr 19, 2022. Past performance is no guarantee of future returns. Real results may vary. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only.

At Citi Global Wealth Investments, we doubt that the Fed will indeed tighten as much as that. Instead, we expect rates to peak at some time in 2022. And, even if the Fed did tighten as much as it is suggesting, history suggests it would then be cutting rates again just six months later or so. Amid all the uncertainty, many investors are asking the same question: Isn’t now a good time to hold cash?

Despite the rise in interest rates, the owners of cash remain in much the same situation as before. After adjusting for inflation, rates in most leading economies remain deeply negative. In the US, consumer price inflation recently hit 8.5%, several points above most short and long-term interest yields. While readings may not stay this extreme, interest rates below the rate of inflation could be a fact of life for some time to come.

The effect of this for the owners of cash is painful. We compare the process to the exploits of a cash thief, who silently steals your purchasing power year after year – see Beat the cash thief! in Outlook 2022. Far from offering safety, therefore, we warn that sitting on lots of cash risks leaving you much poorer over time.

Defending against the cash thief

In our view, the cash thief’s exploits call for taking action. Our preferred approach is to put cash to work in assets that may generate a positive real income for portfolios.

In recent years, ultra-low yields on many bonds have left them as vulnerable as cash. A few months into 2022, however, and the situation now looks rather different. If you have been waiting for a rise in yields, we believe your wait is now over – see Bonds are back!

We also favor core allocations to dividend growers, companies with a track record of growing shareholder payouts throughout economic cycles. These higher-quality, more defensive equities have outperformed during a volatile first half of 2022, and we have historically seen dividend growers beat the broad market with lower volatility over the long-run. Commodity producer equities also have attractions.

One possibility for qualified and suitable investors is certain capital markets strategies that seek to turn higher equity market volatility into a source of income. Likewise, various private market strategies may also help mitigate inflation’s impact – see Alternative paths to portfolio income.

Seeking a positive real income can help defend the purchasing power of your wealth. We believe it is time to get portfolios fully invested and keep the cash thief at bay.

Download the full report

Contact us

To help put you in touch with the right advisory or team, please answer the following questions.