2022 proved to be a defining year for institutional cash investors. An era of low interest rates that lasted more than a decade was flipped on its head, as we entered a new era of interest-rate increases amidst a confluence of economic events. The Federal Reserve tightened policy at a nearly unprecedented speed, raising its target federal funds rate by a cumulative 425 basis points (bps) from March to December. As a result of the higher interest rates, cash investors had a banner year, especially in the context of broader market returns. (See Figure 1, below.)

However, lightning rarely strikes twice. Cash portfolio managers facing new uncertainties as we enter 2023 are confronting a quandary: Should they stay with very short but safe instruments, such as money-market funds or overnight deposits with yields that lag the federal funds rate? Or should they grab higher yields in longer-term securities and risk opportunity costs if future rates exceed current projections?

Their answers will determine what course cash investors set for their portfolios. The Fed has signaled that it's nearing the end of its tightening campaign, which strengthens the case for adding some duration in portfolios to lock in the benefits of higher rates. But there's no certainty over exactly when the tightening cycle will end. Although the economic outlook is rapidly deteriorating, inflation remains elevated. And despite some high-profile tech layoffs, the labor market is strong, with unemployment holding at 3.5 percent.