Fixed-Income Outlook: The View from Higher Elevations (2024)

Good news for bond investors: yields are likely to stay higher for longer. We share strategies for making the most of this environment.

Dovish hikes? Hawkish pauses? Fixed-income investors are struggling to make sense of today’s economic landscape—and many remain reluctant to return to the bond market less than a year after it experienced its worst-ever annual returns. Recent volatility has only added to investors’ concerns. So why, in our view, do these same conditions signal a good entry point for fixed-income investors?

Rates to Stay Higher for Longer, Not Forever

Central banks were in the spotlight in September: the European Central Bank raised rates for what is likely the last time in this cycle; the Bank of England stood pat after 14 consecutive hikes; and the Federal Reserve paused, while simultaneously erasing two projected rate cuts in 2024 from its closely watched “dot plot.”

Despite compelling evidence that central banks have likely completed or nearly completed their hiking cycles, yields have continued to rise globally and are now at cyclical highs. We think this is due in part to market technicals such as increased Treasury supply and in part to policy guidance—that is, it may be some time before central banks reverse their steps and begin to ease. Thus, policy rates—and bond yields—are likely to stay higher for longer.

But higher for longer does not mean higher forever. In our view, yields will eventually trend lower as economic growth slows. Any combination of factors—continued deceleration in inflation, slowing labor markets, a lingering auto strike—could bring economies to heel, driving down yields and boosting bond prices. In the meantime, elevated yields are good for bond investors, since over time most of a bond’s return comes from its yield.

Credit Conditions Call for Cautious Optimism

Of course, sustained higher interest rates are also likely to lead, eventually, to a turn in the credit cycle. Rate hikes are already weighing on activity in many sectors. Households have nearly depleted savings accumulated during the pandemic. Leverage is creeping higher. And interest coverage—the ratio of a company’s EBITDA to its total interest payments—has begun to decline.

But because corporate fundamentalsstarted from a position of historic strength (Display), we’re not expecting a tsunami of corporate defaults and downgrades. In fact, we believe that both government bonds and credit-sensitive sectors have a role to play in portfolios today.

Strategies for Today’s Environment

In our view, bond investors can thrive in today’s environment by adopting a balanced stance and applying these strategies:

1. Get invested.We’ve recently observed that many investors, despite believing that yields will remain flat or fall over the next year, are underweight fixed income, with insufficient duration and credit exposure but meaningful exposure to the volatility of the equities market. We think that’s a dangerous game. The odds of meeting your investment goals over any reasonable horizon are much poorer when you’re not fully invested.

If you’re stillparked in cashor cash equivalents in lieu of bonds—the T-bill-and-chill strategy made popular in 2022—you’re losing out on the daily income accrual provided by higher-yielding bonds. Indeed, overall income levels are the highest they’ve been in 16 years. For example, as of September 27, theglobal high-yield marketoffered yields of 9.4%, on average, compared to three-month T-bills at 5.6%. Remember, fixed-income returns are mainly derived from earning income with the passage of time.

What’s more, markets move swiftly, making market timing next to impossible. Once the tide begins to turn, sidelined cash tends to flood back into the market, rapidly driving yields down and prices up.

To us, it makes more sense to be early in this environment—locking in high starting yields and putting up with some near-term volatility as markets react to economic releases—than to risk being too late.

2. Extend duration.If your portfolio’s duration, or sensitivity to interest rates, has veered toward the ultra-short end, consider lengthening your portfolio’s duration. As inflation falls, the economy slows and interest rates decline, duration tends to benefit portfolios. Then get tactical, modestly shortening the portfolio’s average interest-rate exposure when yields drift lower and modestly lengthening when yields rise. Government bonds, the purest source of duration, additionally provide ample liquidity and help to offset equity market volatility.

3. Hold credit.Yields across risk assets are higher today than they’ve been in years, giving income-oriented investors a long-awaited opportunity to fill their tanks. “Spread sectors” such asinvestment-grade corporates, high-yield corporates and securitized assets—including credit-risk-transfer securities—can also serve as a buffer against inflation by providing a bigger current income stream.

But credit investors should be selective and pay attention to liquidity. CCC-rated corporates (particularly in cyclical industries), lower-rated emerging-market sovereigns and lower-rated securitized debt are most vulnerable in an economic downturn. Conversely, short-duration high-yield debt offers higher yields and lower default risk than longer debt, thanks to an inverted yield curve. Careful security selection remains critical.

4. Adopt a balanced stance.Strikingthe right balancebetween interest-rate and credit risks can be a good idea in the late stages of a credit cycle. Among the most effective strategies are those that pair government bonds and other interest-rate-sensitive assets with growth-oriented credit assets in a single, dynamically managed portfolio. This approach can help managers get a handle on the interplay between risks and make better decisions about which way to lean at a given moment.

Correlated sell-offs of government bonds and credit assets have been exceedingly rare over the last 30 years. Yet even when the two types of assets do decline in tandem, a barbell strategy may help to minimize the damage. Those who segregate rate-sensitive and credit assets in different portfolios may be tempted in such situations to sell—and lock in losses—in both.

5. Consider an active systematic approach. Today’s environment of higher rates and challenging economic conditions also increases opportunities in the form of higher potential real returns and active fixed-income security selection. We believe that systematic fixed-income investing approaches, which are highly customizable, can help investors harvest these opportunities. Because systematic approaches depend on different performance drivers, their returns will likely differ from—and complement—traditional active strategies.

Take in the View from Higher (Yield) Elevations

Active investors should stay nimble and prepare to take advantage of quickly shifting valuations and fleeting windows of opportunity as the year progresses. Most important, investors should get off the sidelines and fully invest in the bond markets to take advantage of today’s high yields and potential return opportunities. After all, the view up here is hard to beat.

Fixed-Income Outlook: The View from Higher Elevations (2024)

FAQs

Should you buy bonds when interest rates are high? ›

Should I only buy bonds when interest rates are high? There are advantages to purchasing bonds after interest rates have risen. Along with generating a larger income stream, such bonds may be subject to less interest rate risk, as there may be a reduced chance of rates moving significantly higher from current levels.

What is the best fixed-income investment? ›

Best fixed-income investment vehicles
  • Bond funds. ...
  • Municipal bonds. ...
  • High-yield bonds. ...
  • Money market fund. ...
  • Preferred stock. ...
  • Corporate bonds. ...
  • Certificates of deposit. ...
  • Treasury securities.
Mar 31, 2024

What does fixed-income refer to in the context of bonds? ›

Fixed-income securities are debt instruments that pay a fixed rate of interest. These can include bonds issued by governments or corporations, CDs, money market funds, and commercial paper. Preferred stock is sometimes considered fixed-income as well since it is a hybrid security combining features of debt and equity.

How does fixed-income work? ›

Fixed-Income securities are debt instruments that pay a fixed amount of interest, in the form of coupon payments, to investors. The interest payments are commonly distributed semiannually, and the principal is returned to the investor at maturity.

Is it better to buy bonds when inflation is high? ›

While bond returns are typically poor during periods of high inflation, they can provide valuable income when inflation and prices fall. Shares tend to behave differently. Inflation can act as a natural drag on the value of returns investors receive.

Is 2024 a good time to buy bonds? ›

As inflation finally seems to be coming under control, and growth is slowing as the global economy feels the full impact of higher interest rates, 2024 could be a compelling year for bonds.

Where is the safest place to put your retirement money? ›

The safest place to put your retirement funds is in low-risk investments and savings options with guaranteed growth. Low-risk investments and savings options include fixed annuities, savings accounts, CDs, treasury securities, and money market accounts. Of these, fixed annuities usually provide the best interest rates.

Is this a good time to invest in fixed income? ›

Investing in fixed-income instruments can be beneficial even in a bull market due to attractive yields. Current interest rates offer real returns above expected inflation, making it a good time to lock in rates.

What is the safest fixed income investment? ›

Treasuries are generally considered"risk-free" since the federal government guarantees them and has never (yet) defaulted. These government bonds are often best for investors seeking a safe haven for their money, particularly during volatile market periods.

Is it better to buy bonds when interest rates are higher or lower? ›

purchase bonds in a low-interest rate environment.

The longer the bond's maturity, the greater the risk that the bond's value could be impacted by changing interest rates prior to maturity, which may have a negative effect on the price of the bond.

Is it a good or bad time to buy bonds? ›

Short-term bond yields are high currently, but with the Federal Reserve poised to cut interest rates investors may want to consider longer-term bonds or bond funds. High-quality bond investments remain attractive.

Is it a good idea to buy bonds now? ›

That combination of relatively high yields, reasonable prices, and an expanding opportunity set may not offer the sizzle of a high-flying stock market but that may be exactly the reason to consider adding bonds to your portfolio in the months ahead.

Is right now a good time to buy bonds? ›

Answer: Now may be the perfect time to invest in bonds. Yields are at levels you could only dream of 15 years ago, so you'd be locking in substantial, regular income. And, of course, bonds act as a diversifier to your stock portfolio.

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