Is Your Fixed Income Allocation in Order?

Doug Drabik discusses fixed-income market conditions and offers insight for bond investors.

As long as the opportunity exists, we are compelled to present it. Yields in spread products are comparatively favorable looking back more than a decade in time. CDs, corporate bonds, and municipal bonds all have favorable curve positions appealing to a wide array of investor needs. Although the primary function of fixed income is often protection of principal and an offset to growth asset risk, market conditions have provided relatively high yields and coveted cash flows for investors ready to take advantage of this. How long this window stays open is in question and perhaps suggests a hastening of action.

The FOMC committee met last week and raised the Fed Funds rate by another 25 basis points (bp), bringing the total rate hike to 500bp over just 17 months. This is an extreme change in a short period of time. For the first time in this cycle, the Fed included language to suggest that the hike cycle may or may not continue. This is important because until now, they were unwavering about their stance to continue raising rates until inflation was under control. Although inflation numbers have fallen substantially, they are pointedly far from target levels. The Fed’s actions have created an inverted Treasury curve as short-term rates have pushed higher while intermediate and long-term rates have not kept pace.

The graphs show previous yield curve inversions (gold lines) at their widest inversion and compare how the yield curve looked one year later (blue lines). These graphs represent the inversions prior to the Great Recession and to the COVID recession. Previous inverted curves offer similar outcomes. Inverted Treasury curves are an indicator of lower future rates.