Get Ready For 5% Money Markets: VGSH Appealing, But Not Best For Your Cash (VGSH)

The Fed is focused on economic data and corporate earnings. A bevy of key reports both at the macro and firm-specific level will impact how Chair Powell and the rest of the FOMC outline monetary policy in the coming months.

Earnings Onslaught This Week

As it stands, traders expect a final quarter-point rate hike to be announced Wednesday next week, bringing the Fed Funds rate above 5%. That will make money market mutual fund yields very attractive and a high hurdle rate for equities.

Rates Seen Rising One More Time, Holding High Through Q3

What’s interesting now is that stashing your cash in a short-term Treasury ETF may not be the best move to secure the best yield. Consider that come late next week, a low-cost money market will yield more than 5% annualized. Contrast that to the popular U.S. 2-year Treasury rate which hovers near 4.2% even after a rebound in rates over the last few weeks. Moreover, cash yields may continue to run near the 5% market through year-end if the CME FedWatch Tool is any indication.

Today, I am looking at the Vanguard Short-Term Treasury Index Fund ETF Shares (NASDAQ:VGSH). I like this fund for its ultra-low annual expense ratio of just 4 basis points, and the current yield to maturity is 4.1% – that will be about 0.9 percentage points under the Vanguard Federal Money Market Fund (VMFXX) yield that will likely be 5.02% following the Fed rate announcement next week.

I continue to assert that cash in your investment portfolio or for your emergency fund should be in a money market fund – and be sure that its 7-day SEC yield is above 4.6% right now.

VGSH Distributions On The Rise

As for VGSH, you might wonder why you even own it given this interest rate environment. Well, the upside is if there is a recession, the growth downturn will likely mean lower interest rates sooner rather than later. In such an event, the NAV of VGSH will creep higher, producing a capital gain along with the income yield. A money market mutual fund, however, will stay pegged at $1 while its rate could fall if the Fed were to slash rates.

Recession Risk Seen at 65%

Interest rate risk is thus a possible benefit for VGSH holders. Of course, if you ardently hold a lower-rate view, then taking more duration exposure by stepping out on the maturity spectrum makes more sense. VGSH could be your happy middle ground with its short duration and still-decent yield to maturity.

VGSH has a low 2-basis point 30-day median bid/ask spread and average daily volume is high at more than 3 million shares, according to Vanguard. So, tradeability and liquidity are strong. The average effective maturity of the fund is 2.0 years, so it is comparable to the iShares 1-3 Year Treasury Bond ETF (SHY). Total assets in the ETF sum to more than $25 billion and it of course is plotted in the upper-left section of the Morningstar fixed-income style box. VGSH is a gold-rated fund by the research outfit, by the way.

VGSH: Gold-Rated, Best In Breed

VGSH Preferred Over Higher-Cost SHY

The elephant in the room is what happens with short-term government debt. The cost to insure 6-month maturity Treasuries has jumped to 150 basis points – the highest in more than 15 years, according to Michael McDonough. The 2023 debt-ceiling showdown is seen as more serious than the turmoil surrounding the 2011 U.S. Treasury downgrade and the 2013 debt-ceiling debate. Still, I do not foresee the political stalemate materially impacting what Treasury investors should expect to earn on their holdings.

US CDS Cost On the Rise Ahead of the Showdown

The Bottom Line

I am a hold on VGSH. I see it is top in class as a short-term Treasury ETF given its rock-bottom expense ratio and tight bid/ask spread. I prefer it over SHY. But with money market yields soon to be above 5%, I would rather keep it simple at this point with something like VMFXX.