As the second half of the year unfolds, fixed-income investors may find it necessary to make adjustments to their portfolios. Initially, there were expectations of multiple interest rate cuts by the Federal Reserve, but the central bank has held the federal funds rate steady between 5.25% and 5.50%. Despite this, there is anticipation of rate cuts in the coming months, possibly starting in September. The Fed hinted at a single reduction before the year-end during its June meeting, but the prevailing sentiment on Wall Street suggests the likelihood of two cuts by the end of the year.
Chief fixed-income strategist at Charles Schwab, Kathy Jones, points out that the potential for rate cuts is influenced by falling inflation and a cooling labor market. Both the price data and the jobs market are nearing the Fed’s targets, and real interest rates, post-inflation, remain elevated. Jones foresees improved returns for fixed income in the latter part of the year but expects volatility to remain high. To enhance performance, finding the right mix of fixed-income asset classes will be crucial.
In the current economic landscape, Kathy Jones underscores the importance of considering longer maturities by adding some duration to portfolios. While Treasurys remain a staple holding, Jones suggests looking beyond them for potentially higher gains. She highlights investment-grade corporate bonds and government agency mortgage-backed securities in the six- to seven-year timeframe as offering attractive yields and potential price appreciation. Despite tight spreads in investment-grade bonds, the absence of a looming default cycle provides investors with a sense of security.
JPMorgan also advocates for a barbell approach, combining short-term Treasurys with investment-grade bonds and agency MBS. The bank predicts an inverted yield curve until the end of 2024 but projects a positively sloped curve by 2025. By extending duration gradually, investors can capitalize on attractive yields while hedging their portfolios against market fluctuations. Wells Fargo emphasizes the importance of credit quality while the yield curve remains inverted, suggesting a focus on high-quality assets such as municipal bonds and securitized products like residential mortgage-backed securities.
As investors navigate through economic uncertainties, prioritizing credit quality and diversifying fixed-income holdings can provide stability and potential returns. Municipal bonds offer tax advantages for high-income investors, while residential MBS present relative value compared to investment-grade corporates. Keeping an eye on deficits and fiscal policies, investors can position their portfolios strategically for potential changes in tax rates and market conditions. Amid discussions of economic challenges, maintaining a balanced and diversified fixed-income portfolio remains essential for long-term financial success.