Higher Rates Makes Fixed Income Attractive Again
Earlier this month the Federal Reserve raised the policy rate by another 75 basis points to 4% for the first time since 2007. In just eight months, it has raised rates 375 basis points.
Earlier this year, the Fed was focused on getting policy rates higher “expeditiously” to fight against potentially spiraling inflation expectations and financial conditions that were too easy. Now, it seems it will still be taking rates higher, but the pace will be slower.
There is good news and bad news here for markets. The bad news is that the higher rates go, the higher the chances that we get a recession. The good news is that a slower pace should also work to reduce volatility across markets and could provide an opportunity for the Fed to notice meaningful turning points in either growth or inflation.
Stocks fell after the meeting, but zooming out, the S&P 500 is still positive over the last month, with the cyclical sectors outperforming. Bond yields are unsurprisingly on the rise. Two-year Treasury yields are trading at cycle highs, but the reaction in the 10-year yield was much more muted.
Learning to love fixed income again
For most of the last decade, it has been hard to love fixed income. First of all, your potential return is capped in bonds and infinite in stocks. Low interest rates offered investors paltry income and limited protection in the case of an economic downturn. A feature of monetary policy was to get money out of the safety of bonds and into riskier assets or the real economy. Core fixed income has only returned 7.5% cumulatively over the last 10 years.
‘Earlier this year, the Fed was focused on getting policy rates higher … Now, it seems it will still be taking rates higher, but the pace will be slower.’
But now, after an aggressive campaign of rate hikes from global central banks and one of the worst selloffs in bonds on record, we are learning to love fixed income again. Bonds will likely become more valuable as the global rate hiking campaign reaches its final stages and the real economy starts to feel the consequences. The asset class is once again a viable option for both income and total return in portfolios.
Rick Barragan is the Managing Director, Los Angeles Market Manager, for J.P. Morgan Private Bank.
[email protected] | (310) 860-3658
privatebank.jpmorgan.com/los-angeles
