Midyear Rate Review
Doug Drabik discusses fixed income market conditions and offers insight for bond investors.
I’m going to start with the conclusion or take-away. Asset allocation (portfolio balance) is important regardless of the current interest rate environment. The fixed income allocation’s primary objective for many investors is principal protection and this is accomplished with long term strategies that don’t rely on total return (price appreciation) objectives; therefore, the need to forecast the future is lessened.
This is an advantage to fixed income mostly for the reason that forecasting, at best, is difficult. The following graph highlights the 10-year Treasury forecast of experts. The red lines are the forecasts, the blue line is how the 10 year Treasury actually performed. The experts are wrong more often than they are right. This is not a judgement on their expertise but rather a demonstration of how difficult it is to predict how the vast amount of economic variables will actually unfold.
Still, looking rationally and intellectually at the future can provide awareness and direction for optimizing the fixed income allocation in terms of principal protection, as well as income and cash flow.
Bloomberg, a well known service in the financial industry which delivers news and analytics, publishes a composite forecast from world economists. Their outlook for the 10-year Treasury at year end is 1.88%. Raymond James’ economist, who submits a forecast in this survey, sees the 10 year Treasury settling at 1.98% at the end of 2021. Our Fixed Income Solutions team expects the 10 year Treasury to wind up in the 1.50%-1.80% range. The opinion of this author can envision a way in which yields finish the year even lower than these forecasts with the 10 year closer to 1.25%.
If you have an opinion, you can likely find some expert to justify your number. The common thread though, appears to be that nearly every expert opinion is a generally low rate prediction. Whether the 10 year Treasury ends up as low as 1.00% or as high as 2.50%, they both reflect a relatively low interest rate environment.
The uncertainty and generally low rate anticipation suggest that strategies targeted to principal protection, yet moderate duration will allow investors to reassess as cash flow and maturities provide more rapid dollar turnover.
Step back from trying to predict the future long enough to evaluate what is currently happening in the market. Stimulus programs are still flooding the market. The insertion of cash has fueled the stock and bond market and may likely continue to do so. Although there has been talks of taper, it has not come to fruition. Quite the opposite as the government continues to purchase assets thus contributing to driving prices up. Let’s also not discount that Federal Reserve Chair Powell has not swayed from his position or intent on keeping interest rates low. The Fed has direct control of short term rates through setting the Fed Funds rate but also influences longer term rates via their asset purchases.
Pocket inflation is real and supply chain disruptions are a primary contributor. Suggesting that inflation isn’t present is like suggesting a hot branding iron won’t hurt to touch. However, there is no evidence to suggest it will be permanent. Several supply chain “clogs” are loosening and correcting during the economic reopening phase. Pent up demand is beginning to show up for services shut down in the pandemic (hotels, airlines, restaurants, etc.). There is also a cautious approach by many due to the uncertainty of the future. Sidelined cash is not earmarked solely for consumption as much of it finds its way to paying down debt and investments.
It appears we will remain in a low rate environment for longer. Work with your advisor to continue your long term strategy for fixed income. Principal protection remains a primary objective while keeping cash flows regular may mitigate interest rate risks. Keep the total return portion of your portfolio in products that you think will appreciate in price and the wealth preservation portion in products that are intended to preserve wealth.
To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.
Stocks are appropriate for investors who have a more aggressive investment objective, since they fluctuate in value and involve risks including the possible loss of capital. Dividends will fluctuate and are not guaranteed. Prior to making an investment decision, please consult with your financial advisor about your individual situation.