As interest rates rise, is cash king again?

Savers can get a higher return today but the stock market will generate a better yield for investors in the long term, experts say

The US dollar is king now because it is the only safe haven asset that gives both value and higher yields. Reuters

The old phrase “cash is king” seemed like a relic from another world for the past 12 or so years as interest rates hit rock bottom and stayed there.

Hopes of a comeback for cash were repeatedly squashed by central banks, which slashed rates at the first sign of economic trouble and supported shares with endless stimulus packages.

Now, monetary policy has dramatically shifted as central banks turn hawkish in a desperate bid to curb the inflation they unleashed with easy money policies.

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Watch: US Fed chief warns of 'pain' in reducing inflation

Last Wednesday, the US Federal Reserve increased its funds rate by 0.75 per cent for the third meeting in a row to between 3 per cent and 3.25 per cent, the highest level since 2008.

The Fed now expects rates to hit 4.4 per cent by the end of the year, a full percentage point higher than it projected in June. It signalled that it will crush inflation even at the cost of driving the US economy into recession, triggering another sell-off in shares.

The S&P 500’s summer bear market rally had the permanence of a holiday romance. It is now down 21.65 per cent year to date.

Supposedly low-risk bonds crashed, with prices falling 11.6 per cent this year, while Bitcoin bombed and gold lost its shine because it pays no interest.

Cash is back. So, should you be holding more of it?

For more than a decade, the argument against cash was easy to make. It paid next to no interest, while shares offered capital growth from rising markets with dividend income on top.

Now, shares are falling while best-buy savings rates rise past 3 per cent, with more to come.

This is still a fraction of the inflation rate, which in August stood at 8.3 per cent in the US, 9.1 per cent in the eurozone and 9.9 per cent in the UK.

Money held in cash is still losing its value in real terms, and pretty rapidly, says Laith Khalaf, head of investment analysis at AJ Bell.

“Cash is king for short-term money, but it is still subject to the ravages of today’s double-digit inflation,” he adds.

Yet, if central banks continue to tighten, savings rates climb past 5 per cent and 6 per cent and inflation falls, cash could look more attractive.

Savers face a tough choice: should they lock into a best-buy deal today or wait for rates to climb higher?

Delaying has its dangers, says Derek Sprawling, savings director of UK-based lender Paragon Bank.

“You may find yourself waiting for a rate that may never appear, while missing out on six months of rates close to the eventual peak,” he adds.

Another problem is that real yields remain in negative territory, with inflation above 8 per cent in the US, Europe and the UK, says Chaddy Kirbaj, vice director at Swissquote Bank.

“Rather than rely on your bank's passive income, putting your money to work will add more value in the long run,” he adds.

International investors face another challenge as major currencies such as the euro, sterling and Japanese yen are crashing in value, when measured against the US dollar, Mr Kirbaj says.

“Cash is not king. The US dollar is king. It is now the only safe haven asset that gives both value and higher yields.”

“There is simply no alternative to the greenback” as the US Dollar Index has climbed 20 per cent in the past 12 months to its highest level in two decades, Mr Kirbaj says.

The US dollar is the world’s reserve currency, which makes it a natural safe haven in times of trouble, while Fed rate raises mean investors get a better return on dollar-denominated assets.

“The easy and safe way to generate returns is by holding assets in US dollars, as this proofs you against risk and volatility,” Mr Kirbaj suggests.

Investors might consider holding up to 40 per cent or 50 per cent of their assets in dollars, he adds.

“The fall of equities, bonds and alternative assets will create better valuations in the coming weeks and months.”

Beware the temptations of parking your money in cash too long, says Chris Ainscough, fund manager at wealth manager Charles Stanley.

“Holding a bit more cash during periods of volatility or in anticipation of falling markets can be appropriate, but it requires you to correctly time markets twice,” Mr Ainscough says.

“Once to sell out of your investments into cash and once to buy back in to markets after they have fallen.”

With perfect timing, a fortune could be made — but that is unlikely.

“For those with a long enough time horizon, we would advocate remaining invested in line with their risk appetite rather than trying to flip in and out of markets tactically,” Mr Ainscough adds.

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Watch: US inflation hits 40-year high of 9.1 per cent

Once inflation is under control, central banks will stop increasing rates, which are likely to peak in the spring, says Vijay Valecha, chief investment officer at Century Financial.

“The Fed funds rate is expected to hit 4.9 per cent in March, then fall to 4 per cent by the end of 2023 and 3.9 per cent by December 2024.”

Now could be a good time to play the interest rate recovery, although not through cash.

Investors could take advantage of falling bond prices and buy them instead, Mr Valecha says.

“As the Fed hikes, inflation projections are beginning to come down. While it may be too early to lock into cash, bonds tempt as they have priced in a significant amount of rate hikes.”

He tips three exchange-traded funds (ETFs) as a way of gaining exposure to higher rate projections: Fidelity Total Bond ETF, iShares Core Total USD Bond Market ETF and iShares Core US Aggregate Bond ETF.

While it is good news that savers can get a higher return, the stock market should still generate a superior return over the longer run, says Steve Cronin, a financial independence coach and founder of Deadsimplesaving.com.

“Cash has a specific purpose in personal finance, which is to save towards specific short or medium-term goals and to provide an emergency buffer against unexpected surprises,” he says.

Banks' reluctance to pass on rising interest rates is partly to blame.

“If they started paying 7 per cent or more, then maybe cash would get more of my attention.”

We have been here before in the 1970s, Mr Cronin says.

“After a tough decade for stock markets, in 1979 Business Week magazine trumpeted 'The Death of Equities: How Inflation is Destroying the Stock Market’. Yet the market bottomed out in 1982 and has since increased more than 7,000 per cent.”

Even if stocks have a rough couple of years ahead, over the long term, diversified stock funds will hugely outperform cash, Mr Cronin says, adding: “You should always be investing for the long term.”

Cash is not quite king, but it is no longer down and out, either.