CIO thinks that cash rates are likely to fall and that current bond yields can be locked in, providing a more durable source of portfolio income. (UBS)
CIO recommends investors build an active and diversified fixed income exposure. Complementing a core holding in quality bonds with a satellite in higher-yielding parts of the fixed income market can improve overall portfolio yields.
Recent data point to a moderation in US economic activity.
- The June labor report added to evidence that the demand for workers is moderating, with the unemployment rate edging up to the highest level since November 2021.
- Both the core consumer price index and core personal consumption expenditure for May showed further deceleration in inflation. Other data have also been consistent with an economy heading for a soft landing.
- The 10-year US Treasury yield stood at 4.27% as of 5 July, down from over 4.7% in April.
This weakening in data should be sufficient to justify a first Fed rate cut in September.
- Fed officials acknowledged “diminishing” price pressures in their June policy meeting.
- We expect the 10-year US Treasury yield to fall to 3.85% by December.
- We think markets will start to price a lower level of long-term interest rates once the Fed begins to reduce rates.
Fixed income remains our preferred asset class.
- High-quality corporate and government bonds have attractive yields and the potential for capital appreciation if markets start to price deeper rate cuts.
- This also applies to sustainable investments into green, social, and sustainable bonds, as well as those issued by multilateral development banks.
- Complementing a core holding in quality bonds with a satellite in riskier credits can potentially improve overall portfolio yields.
Did you know?
- In their latest projections, Fed officials put their estimate of the longer-run fed funds rate at 2.8%, much lower than the current market pricing.
- Historically, bonds delivered higher returns than cash over the long term, and their probability of outperforming cash rises with longer holding periods—from 65% over 12 months to 82%, 85%, and 90% over five, 10, and 20 years, respectively.
- We prefer medium-duration bonds with a maturity up to 10 years, as we think concerns about the high US debt burden and loose fiscal policy may pose a risk for longer-duration bonds.
Investment view
While we think cash rates are likely to fall, current bond yields can be locked in, providing a more durable source of portfolio income over time. We like quality bonds for their attractive risk-return proposition, and we think complementing the core holding with a satellite in riskier credits can potentially improve overall portfolio yields.
Main contributors: Daisy Tseng, Vincent Heaney
Original report - Is it time to lock in bond yields?, 8 July 2024.
