Fixed income perspective – from the Investment Advisory Group

Recent upward yield move is restoring value in duration

• Intermediate and long-dated U.S. Treasury yields have drifted back to their highest levels since March in response to some hawkish Fed rhetoric and better than expected economic data. The 10-year U.S. Treasury yield is currently trading at 3.73%. On Tuesday, the 30-year briefly eclipsed 4%.
• In late October, the 10-year U.S. Treasury yield touched 4.25%, towards the top end of our expected trading range for 2023. We used that period as an opportunity to upgrade our views on duration, recommending a slightly long-of-benchmark posture. We believe October will hold as the high watermark for the 10-year yield in this cycle.
• The banking sector’s challenges in March prompted us to lower the upper end of the 10-year’s projected trading range to roughly 3.75-4%. We suspect tighter lending standards combined with the cumulative impact of the Fed’s aggressive rate hikes will make any move above 4% difficult for the 10-year to sustain.
• Given our expectation that U.S. Treasury yields will trend lower in the back half of the year, the recent rise to roughly 3.75% suggests that significant value is being restored in longer duration, high quality fixed income, particularly in actively managed fixed income portfolios that remain well short of their benchmark.
• Historically, longer duration and higher quality fixed income has tended to outperform shorter-dated and lower-rated bonds as the economy slows or enters a recession. They also tend to enhance portfolio stability during periods of stock market volatility. Our expectations for slower growth and choppiness in equity markets this year support an aggregate portfolio duration beyond neutral.
• From a yield perspective, the higher entry point is valuable for two primary reasons: 1) attractive income; 2) greater runway for price appreciation during risk-off periods. For illustration, the 10-year yield declined from 4.06% to 3.38% as banking concerns peaked in March. This equated to a 6% price rally, while the S&P 500 declined -0.3%.
• We anticipate elevated rate volatility and challenging liquidity conditions to continue as Fed balance sheet reductions persist and new economic data are released. Therefore, the risk of overshoots in either direction remains above average. However, the Fed’s need to hold policy rates high until inflation consistently falls creates a difficult macro backdrop and supports our view that the broader trend in U.S. yields will be lower from current levels. 

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