Research

Bond Market Commentary

Midyear Rate Review

Doug Drabik
June 14, 2021

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.


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