Return Expectations for Fixed Income are Higher
Bond markets experienced extreme interest rate moves during the third quarter, against a backdrop of sticky inflation, resilient economic growth, government deficit concerns, and shifting monetary policy expectations. The 10-year Treasury yield touched the highest level in over 20 years and now sits closer to the long-term average after decades of low interest rates. While price movement has been painful in the near-term, current starting yields, a reasonably strong indicator of future fixed income performance, put the long-term outlook for fixed income returns at a favorable level.
The Coupon Cushion is Supportive
The Federal Reserve hiked interest rates in September, the first time since 2023. With yields higher, the risk/reward trade off in fixed income is skewed positive. Due to the increased cushion from income, the Bloomberg Agg can withstand an approximately 100 basis point move higher in rates and still “break even” over a 12-month period. For context, this cushion was only ~25 basis points at the start of 2022. Conversely, there is meaningful upside potential should rates move lower from here.