Mid-Year Outlook: Fixed Income

Interest rates have risen since the start of the year, contrary to consensus expectations. The major driver behind the shift up in rates was change in expectations about the path of Federal Reserve policy. Coming into the year, based on federal funds futures markets, the market expected up to six cuts in the Fed's policy rate —the federal funds rate—which would have brought it down by 150 basis points (or 1.5 percentage points).

Those hopes were dashed by rebounding economic growth and stubbornly high inflation in the first quarter. Consequently, two-year Treasury yields, which tend to closely track expectations about the path of Federal Reserve policy, rose to as high as 5% compared with 4.3% at the start of the year. Similarly, 10-year Treasury yields have risen by about 50 basis points year to date. Volatility has been elevated, reflecting the rapid change in the outlook for interest rates.

Both two-year and 10-year Treasury yields have risen

Both two-year and 10-year Treasury yields have risen

Source: Bloomberg. Daily data as of 6/7/2024.

U.S. Generic 2-year Treasury Yield (USGG2YR INDEX) and U.S. Generic 10-year Treasury Yield (USGG10YR INDEX). Past performance is no guarantee of future results.

Returns to investors have been mixed. Riskier segments of the market have fared the best, largely due to higher starting yields and coupons offsetting price changes. The intermediate-term Aggregate Bond Index (AGG) which we use as a benchmark, is down fractionally year to date. Meanwhile, returns for aggressive income investments such as preferreds, bank loans and high-yield bonds have been positive.