The 'T-bill and chill' trade is about to end for investors. Here's where JPMorgan says they should invest instead.

• High yields on short-term government debt will come down when the Fed cuts rates.
• JPMorgan notes that the three-month rate will drop from 5.4% to 3.5% over the next 18 months.

High yields in the era of tigter Fed policy have popularized short-term government debt, but investors can't depend on the "T-bill and chill" strategy for much longer, JPMorgan said.

Treasury bills — which mature within a few weeks to a year — have become a go-to investment for passive investors hoping to cash in on high interest rates. As T-bills are sensitive to tighter monetary policy, yields have risen beyond 5% since 2022.

But with rate cuts now looming in September, investors should brace for yields to drop, JPMorgan wrote. The bank expects the three-month bill rate to drop from 5.4% to 3.5% over the next 18 months.

This decline could steepen if the economy slows by more than expected, the analysts added.

Yet, parking money in short-term debt may be a difficult habit for investors to break. According to Bloomberg, money-market funds operating that invest in short-term debt have received $106 billion in August alone, pushing total assets to a record high of $6.24 trillion.

Still, JPMorgan suggests investors reposition.

T-bills have a history of underperforming long-dated bonds when interest rates move lower, and traders may lose out on other opportunities by sticking around in cash-equivalents like short-term Treasurys.

"For fixed income, investors have not missed their opportunity to capture attractive yields, with core bond yields still at 4.4%, but the window is rapidly closing," analysts wrote. "As witnessed this summer, what's here today can quickly be gone tomorrow: 2-year yields dropped 85bps in less than two months."

JPMorgan's advice on rebalancing investments is based on where the economy is headed. Investors will need to determine why the Fed is cutting rates before pursuing a new strategy.

When the Fed eases policy due to a recession, investors should focus on US large-cap and growth stocks. International equities, as well as value and small-cap stocks, typically suffer the most, JPMorgan said.

In fixed-income, investment-grade bonds should be the main focus. Long duration typically outperforms, while high-yielding bonds may result in negative returns.

When the Fed eases policy alongside a soft landing — in which low inflation is achieved without sparking a major downturn — large-cap returns tend to double those of small-caps. Meanwhile, US growth and value equities perform similarly, while risk assets and high-yield bonds can lead to positive returns.