Treasury Liquidity and Fixed-Income Opportunity

Last Edited by: LPL Research

Last Updated: October 20, 2022

Treasury Liquidity and Fixed-Income Opportunity

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Podcast Intro:

From LPL Financial, welcome to Market Signals.

Marc Zabicki:

Welcome everybody to LPL Research's Market Signals Podcast. I am Marc Zabicki, Chief Investment Officer of LPL. Joining me today is Barry Gilbert, who is our Chief Asset Allocation expert on LPL Research. Barry, how are you this morning?

Barry Gilbert:

I'm doing well. It's great to be here. How are you doing, Marc?

Marc Zabicki:

I'm doing fairly well, feeling a little bit better about what we're seeing out of equities. Certainly helpful for general sentiment. We'll talk a little bit about that. This Market Signals podcast is being recorded on Tuesday, October, 18th. And want to just start by saying that we have important disclosures that the audience needs to be aware of. And we have important data on global capital markets that the audience also needs to be aware of. We are getting a little bit of a reprieve in global equity markets here in the last, you know, couple days. That's, you know somewhat significant on the one week returns that we're seeing across the board really in global equity markets, U.S. and other equity markets you know, included in that. Specific strength also from an individual U.S. Equity perspective in financials and healthcare, which is also fairly notable and also relative strength in real estate. So, Barry, I know that as a member of the Strategic and Tactical Asset Allocation Committee here at LPL Research, we often talk about the equity market and obviously prevailing conditions as it relates to Fed expectations and the Fed. And we have indeed been looking for some semblance of a bounce back in U.S. equities and global equities. So, how do you digest the last couple days of trading activity that we've seen?

Barry Gilbert:

Yeah, there's, there's clearly still a lot of uncertainty out there, Marc, but it's the market has become more sensitive to, you know, potential upside news as it's as it's sold off. There's a lot of negative news priced in, when you get a lot of negative news priced in. It means that just small things can, can make a big difference. And we've seen some small things. We're going to talk about them today that have shifted the markets. It's just good to see some positive numbers there.

Marc Zabicki:

Yeah. And that's, that's indeed our, our base case scenario in terms of our asset allocation committee work is that we think a lot of the bad news is priced in. We think a lot of the Fed expectations is priced in. By no means do we think this is a renewable market. We think there could be a better month ahead in terms of equity returns. Volatility is likely going to continue to be high. We've also equated this current timeframe in the market with the 2011 timeframe-ish. And part of the reason for that is just the uncertainty that's bred by Federal Reserve policy and what may or may not happen with interest rate policy and other central bank policies. That was a key driver in 2011. It's clearly a key driver in today's market.

 

So, with us having no, and nobody actually having an absolute and utter clear vision and in terms of what the Fed may or may not do, we think we can make an educated guess on what may happen. But that's certainly a key driver that's been "A" number one in terms of our topics at the Strategic and Tactical Asset Allocation Committee. So, with that, moving on to fixed income, which is, is you've basically been historically a bad place to be in 2022, which is highly unusual relative to what we've seen in equity markets. And we'll talk about the 60/40 portfolio today a little bit, you know Barry, but bonds are having trouble as the 10-year treasury hovers around 4%. We expect that to improve.

 

And we'll talk a little bit more about that, you know, in detail. And then the commodities market we think, in terms of this cycle the good commodities trade is perhaps in our rearview mirror at this point. And largely that's been driven by just the general direction of central bank policy and their efforts to dial down the economic strength globally, which is generally not a good thing for the commodity complex. If I look to some of last week's key drivers, Barry, you know, clearly we talk about Fed expectations till we're blue in the face, but we still are focused on as asset allocators, what's going on at Credit Suisse and the distress that's showing up in parts of that market.

 

The policymakers certainly have their eye on that. Market participants have their eye on that as something that could break, effectively. And I think one of the concerns from market participants is that given all the central bank tightening, particularly at the Federal Reserve level what is likely to break what are central banks going to break perhaps? And you know, Credit Suisse is an example of an institution that's not necessarily ultrasound at this point. So, policy makers have their eye on that market, participants have their eye on that. And the Bank of England backed off from its support of the gilts market following an injection of support, 20 billion pound injection of support to basically offset some of the volatility that was occurring in that market.

 

And I the question here, will the Bank of England governor Andrew Bailey do his best Mario Draghi impression? That means that Mario Draghi famously stated at one point during the Greece crisis effectively that we will do whatever it takes to support the market. I don't know that Andrew Bailey's ready to stand on that hill. Mario Draghi certainly did. But people are keeping an eye on what's happening out of the Bank of England as it relates to the gilts market and to Credit Suisse. Turning to you, Barry, and we'll talk a little bit about the short covering rally on Thursday and what's going on in capital markets over the last, yesterday and today. But the CPI number down month over month on a core basis, PPI number as well. So that's a positive, but the progress is awfully, awfully slow. So, you know, as a STAAC committee, we constantly talk about this, Barry, what's on your mind in terms of the inflation landscape today?

Barry Gilbert:

Yeah, we, we do know we've had a lot of upside surprises. That's what's pushed the the Fed. That's what's caused them to remain stead steadfast on communicating that their emphasis is on fighting inflation. But at the same time, that headline number, we are past peak starting to come down a little bit in STAAC. You know, we take a look underneath the hood and see what's going on with different numbers. We think that pressure's going to be there and might it turn out to happen more slowly than people expect? It very well might. We will have to see but what we don't think is going to happen is it's going to reverse directions or stay elevated. That gravity of starting to pull it down, whatever the pace might be, that gravity is starting to pull it down is starting to be there. And that might be part of what the market was reacting to, the initial reaction before the market even opened. Looking at that number at 8:30 in the morning is, oh, another upside surprise. And then the market may be looking around a little bit and saying, where are we big picture with inflation? Well, things, even with the surprise, they're starting to move in the right direction that momentum might actually be meaningful.

Marc Zabicki:

Yeah. And that's again, you, you focus on our base case as a Strategic and Tactical Asset Allocation Committee. And our view there is that we have an expectation that inflation is going to continue to subside and perhaps the Federal Reserve is going to do less about inflation as we move through the next few months ahead. Not that they're not going to be on their horse in terms of rate increases in the next couple meetings, because we think they are. But we believe that the picture gets better in terms of visibility into falling inflation. We saw that in last week's numbers, not to a great degree, but we did continue to see it ticked down, and again, not as fast as we would've expected but it is moving in the right direction. Inflation expectations as it relates to the University of Michigan survey ticked up a little bit in the near term, but the five to 10 year inflation expectation number continues to be relatively well grounded. Moving to U.S. bank earnings, which I think started out fairly well for the market.

 

You know Barry, I think some of the numbers were, we call it generally serviceable, I think. That's

Barry Gilbert:

Good. Good phrase.

Marc Zabicki:

Good. Yeah. Weakness in IPO activity, but you know, what interest rates increases will give you is improving net interest margins. Any, any comment on the start to earnings season, Barry, especially as it relates to some of the key money center banks?

Barry Gilbert:

Yeah. Not relating to the banks, but just big picture expectations have been taken down a lot. And so, the prospects to top the lower expectations, they're actually pretty good. And so, it's one of the things that we're going to be watching. The first thing is can we top those expectations? Seems likely that we'll be able to, and then is that actually going to have a market impact given that they've been taken down so much. But the setup for earnings season it's actually okay, given lower expectations.

Marc Zabicki:

Yeah. Agreed, and I think so far in terms of the trading activity and some of the money center banks I think those numbers were generally well received. Key economic data this week in the U.S. Just to update where we are from a capacity utilization and industrial production numbers, which we got this morning, not a heavy week of data. And Barry, I want to get, you know, some of your preliminary comments on what may happen in terms of the Fed beige book release. But capacity utilization came in at 80.3 relative to the 80.0 prior month's number and the consensus estimate of 79.8. So, a little bit better than expected in terms of capacity utilization. Industrial production was also better than expected relative to the prior and to the estimate at positive 0.4.

 

What does that mean, effectively, that probably means that supply is continuing to, to rise. So if we think of the supply demand construct that's important in the inflation discussion additional amounts of supply driven by greater capacity, more industrial production activity may create a disinflationary construct of that supply demand balance that we see out there. I don't know that it's that material in terms of its direct and immediate impact on inflation. But something to think about, I mean, one thing that we got when we were constraining supply chains or supply chains were being constrained was that lack of available goods. With capacity utilization and industrial production lifting up, we're getting more and more available goods, which perhaps could put downward pressure on overall prices. Turning to the Fed beige book Barry, couple things that come to mind here in terms of just a general sense of the economy, a general sense of what's going on in the jobs market as the Fed keeps a close eye on both. Any thoughts around what market participants may want to see out of the Fed beige book?

Barry Gilbert:

Yeah, the beige book is the opportunity that the Fed has in a way to talk to Main Street rather than Wall Street. They have business contacts within their districts. They talk to the business contacts, really trying to figure out what's going on the ground that gets put together. And then if you want to, you can do some quantitative work on, on taking that qualitative data and seeing what's in there. But there are really big picture things that we're looking for. This is going to be an early indication on what is going on with the job market. It's a big priority that this very tight job market starts to loosen up. That's part of what they're looking for, that has an impact on inflation. It's continued to remain tight being able to go out and actually speak to people and say, hey, what's going on before all the numbers get put together might give us an early sign. So, I think they're going to be watching that very closely. They also get a sense of what's going on with prices as well and how people are responding to it district by district. So, not surprisingly, those are the two key things, but more of that Main Street perspective. And we get a chance to see more of that Main Street perspective too. And that's significant.

Marc Zabicki:

Yeah. Final talking point for this piece of information. Iitial jobless claims are likely to come in a little bit higher than, than normal, like because of perhaps the Hurricane Ian impact there. So, something to keep an eye on Thursday. Not a whole lot to really take home from what's going on economically in areas outside of the U.S. Probably the biggest key is going to be consumer price index numbers out of the U.K. In the Eurozone consumer confidence on Friday in the Eurozone will be notable. The ZEW economic sentiment number out of Germany was indeed better than expected. So that's something to kind of take note of as well as we look across other areas of the globe. Upcoming this week, we did get the banks starting things off late last week, and we'll see a whole lot of earnings activity over the next several weeks.

 

This week we'll start in earnest in seeing some key companies other than banks start to report. We are expecting 1.9% year over year growth in Q3 EPS out of the S&P 500 index. Barry, we touched on some of the Fed beige book activity. We talked about initial jobless claims, the Bank of England. Another thing that perhaps is not on a lot of people's radars, but the 20th China Communist Party Congress began on Sunday, lasts for about a week, and policymakers in China, they, they have a big decision to make is that, and that decision is who's going to run the country. And it seems to be, it's going to be Xi Jinping again. Barry, I mean, how should investors think about what's going on in China this week?

Barry Gilbert:

Yeah, this is important. The policy in China for a long time has been you get two five year terms as the leader, and then hand it off. As a matter of fact, you prep that handoff five years before you depart so that they have continuity. Xi Jinping has come in, his government has been much more autocratic than we've seen over the last several decades. And he's changing the rules. It's not quite parallel, but you could think about if you are in the United States and we have a limit of two terms for president, and the president came along and, you know, made a change and said, hey, I'm going to be here for three. It would be pretty radical, and it's pretty radical in this case as well.

 

He is very likely to get appointed for a a third term. And that means that he is in charge as much as any leader in China has been over the last several decades. And this means that we're going to get more of the same, which has been challenging, more tension with Taiwan you know, more battles over intellectual property, more of the zero covid policy in the near term. I mean, he's the kind of person who doubles down on all of his policies you know, views it as representing himself personally with what he's doing. And this is going to be, continue to be a challenge for the United States, an important part of our policy. So, it's not going to have an immediate market impact but it's certainly something to watch probably incrementally lowers the attractiveness of emerging market equities for investors.

Marc Zabicki:

Yeah, that's a good point. Barry, I mean, I think maybe back call it 15 years ago that I think the expectation was China was going to, in increasingly westernize its economy and Xi Jinping has some other thoughts about that. And that's apparent in another term from him perhaps continues that general direction of China and that instability on a relative basis in China, and also obviously the instability in Russia is certainly something to think about when it comes to putting money to work in global capital markets. The German economic sentiment we mentioned a little bit better than expected, actually, minus 59.2 versus minus 66.5 consensus expectations. That is directionally positive. And then we're going to get into a little bit of technical support for U.S. equity markets, some conversations around from Janet Yellen, Treasury secretary on a Treasury buyback program.

 

Touch a little bit on what that is, and then cover, and try not to get too wonky with some regulatory ratios, but the supplemental leverage ratio and what that means for capital markets as well. So, let's take a first look at what has been a technical bounce for equity or at least a point of potential bounce here. You know, Barry, putting your technical analysis hat on, we're looking at Fibonacci retracements highlighted by the red arrow at zero, and then the dotted line at 50%. And that's notable back in history and today, as the two circles show. What's the takeaway here?

Barry Gilbert:

Yeah, 50% retracement off of the March bottoms from 2020 going into the highs that we made just at the very beginning of this year. That's a psychologically important level, especially with a market that is selling off and has a negative, a lot of negative sentiment in it. Oftentimes those psychologically important levels can become rally points. This is a little bit reinforced by those being at about the same level as those small peaks that we saw later in the year in 2020. So, we are getting a bounce. We'll have to see how long this bounce lasts, how far it can potentially go but not completely surprising to see the markets approach these points and have these points become, at least in the near term, a rally point for equities.

Marc Zabicki:

Yeah. And we've talked about, you know in several corners of LPL Research about the level of weak sentiment that we're seeing in multiple different indicators. And we have been commenting as an asset allocation committee that indeed the market is over oversold. So, we were ripe for effectively a technical balance. We'll see how long it lasts, and we'll see if there can be any other fundamental drivers that would carry us perhaps a little bit further. So, if I go to one of those potential drivers, if you will, if we can call it that, and this is problematic for the treasury, this is problematic for the Federal Reserve, and this chart measures liquidity in U.S. government security. So higher is not good in terms of treasury market liquidity.

 

And this has been a problem, again, for policy makers in terms of the way they think about it. Something that we've talked about a lot in our asset allocation committee meetings that yes, the Federal Reserve is tightening policy but what are they doing actually to affect liquidity in the treasury market? It's been a chief concern, a point of conversation for us. Indeed, they're impairing the liquidity in the treasury market. And, you know, that has come up in conversation quite a bit from policymakers including Janet Yellen. What has also come up is this, this supplemental leverage ratio. And again, I don't want to get into, you know, regulatory, you know, bank regulation 101 here, but the supplementary leverage ratio is a measure of tier one capital over total leverage exposure. So, what has been talked about in the market is that the Federal Reserve could in fact exclude treasury securities from that leverage calculation and thereby allow financial institutions an opportunity to buy more treasury bonds and not be impaired in terms of their overall 3% ratio limit in terms of the SLR.

 

So, the Federal Reserve took similar action, or this exact action in the months, I believe it was April of 2022, immediately after the beginning of the COVID distress to improve liquidity in the treasury market. If they take similar action, which is, again being talked about in Washington D.C., that ostensibly could, you know, could enhance demand for treasuries and perhaps push down, you know, market interest rates. So why would they do that? Effectively, because of the chart that we just showed you, to enhance liquidity in a market to be, that's being troubled by a relative lack of liquidity. And finally, just again, comments coming from Janet Yellen on her concern over Treasury liquidity. And there's been some conversation around perhaps instituting Treasury buybacks, something that the Treasury Department instituted in the early 2000s, effectively using new issuance to retire existing securities, in effect, to support certain areas of the yield curve.

 

This issue came up in the most recent U.S. treasuries quarterly survey of primary dealers, which has effectively feedback from primary dealers to the U.S. Treasury. Again, feedback around the concern that they have around the lack of liquidity in the treasury market, and perhaps the need for policy makers to do something to step in to firm that relative lack of liquidity. So, something to keep an eye on, perhaps one of the reasons why and we've gotten a little bit of a bounce out of equities and risky assets yesterday, and we continue to see that today. If the Federal Reserve and the U.S. Treasury is going to step in to support the U.S. Treasury market, then that is something to note not only if you're a bond investor, but also if you are an equity investor as well.

 

So, Barry, I'm going to turn to you in terms of this chart. I mean, we've talked a lot about it with Lawrence Gillum, our fixed income strategist, has led the conversation that the upside potential in bonds at this point seem to outweigh the downside risks effectively, if we're thinking about interest rate policy and perhaps peaking interest rates already in the market. We've long talked about as market participants, the relative lack of income producing assets available to us in the market. That's no longer the case today based on the direction of interest rates. So we're looking at fixed income as perhaps an opportunity tough to really say given the, the fixed income market that we've endured so far. But how does the asset allocation committee think about fixed income today in terms of how market participants could consider their exposure?

Barry Gilbert:

Yeah, it's this starting point is just to look at those numbers. You know, the way that bonds work, you know the price that you're going to get for them for when they mature, and that gives them a particular yield. You know what that is upfront. And those numbers have been low for a long time, really low. It's been tough, really tough to be a saver. You just could not get any yield, you could not get any income. If you look at the yields now on different basic asset classes of bond, and that's what you got in the no change column, those are basically the current yields, the broad investment grade bond index, the Bloomberg Aggregate Bond Index, the yield now is over 5%, 5.03%. And that sets your return expectation and gives you an idea of the income that you can potentially generate from it as well.

 

And for bonds, most of their return actually comes from income. This is a different environment for bond investors than we have seen in over a decade. These starting numbers, they're sound, they are a good foundation to start investing. And we do have a little information, well, what if the yields go down and you can see the impact if that happens and that would improve the return, and what if they go up, because we know that that's been a concern as well. Even if they go up a lot from here, and that would be a big move from this point, up a full percent, most of those numbers still gains. So that's the downside piece, right? If we end up on that right hand side, and the numbers are pretty solid, if they stay flat and our expectations are more towards them staying flattish from here, you see what your return expectation is over the next year.

 

And those are just pretty solid numbers. The losses in bonds year to date have been so high, so unusually high that a lot of investors are running away from bonds. But we think that that actually gets it backwards, and that's the conversation that we're having in the Asset Allocation Committee. You know, as appropriate for your portfolio, it's actually potentially a good time to invest in bonds, because those yields are so solid, yields that we really haven't seen in a decade or more. And if you get that return for a bond portfolio, those are some fairly attractive returns.

Marc Zabicki:

Yeah. Yeah, Barry, I mean, it's kind of the whole blood in the streets type of thing, right? Is where, I mean, we've had a terrible bond market, terrible equity market, but if you're approaching retirement and you need to put away some assets for income, or if you're in retirement, you want to put away some, some investments for income you're given a good opportunity to do that given market conditions today. So, we've talked a little bit about that in this forum. And this is just another example of what could happen if we get Treasury department support in the U.S. Treasury market, if we get a change to the SLR policy as we mentioned, that could be bullish for bonds, bullish for equities as well.

 

But I mean, just simply stated, if bonds go nowhere in terms of interest rates the yields are relatively attractive, especially if you are an investor in need of income producing assets. Barry, again, kind of leaning on you here. I know you've done some work around the old 60/40 portfolio and obviously it's been bad news here recently in terms of what we've seen over the last several quarters, but you know, as we kind of just touched on yeah, now maybe a good opportunity and certainly not a time to run away from the old 60/40 allocation.

Barry Gilbert:

Yeah, we get a lot of questions, is the 60/40 dead, should it be avoided? Is it no good anymore? We've had three consecutive quarters of negative returns. We've actually done that twice before or once before where we've had three another time where we've actually had sticks. The difference with the more recent quarters is that usually when you have those long stretches it's driven by negative stock returns. And over the year to date, we've had negative bond returns as well. And that's what's actually, I think, created the challenge and has created the conversation for people is the three quarters that we've had more recently. But we do think it actually sets it up for upside. I think you can arguably even say that looking out over the next decade the conditions are potentially better for 60/40 bond portfolio than they've been in a while.

 

On the bond side, we just looked at that picture that we had with yields. We've seen how far the yields have moved. The yield on the Agg, the broad investment grade benchmark that most people used, year ago that was a little over 1.6% we just saw now it's over 5%. That is a big improvement in the potential return prospect over the long term. The other side of it on the stock side is we often look at valuations and the valuations have come down a lot as well, and that provides a potential boost on the bond side. So, 60/40, it's not dead right now. We think that it's an opportunity. It's very much alive. Now there's a third piece of it that we can add in, which is that we just took a look at what the worst quarters have been for the 60/40 portfolio.

 

Just taking it out of this chart. If we take a look at the next slide and in fact what has happened in the following year, next quarter, next two quarters next year and you can see that the averages are pretty robust. If you take a look at that, this chart is actually just the equity piece of it, not the 60/40 piece of it. So, you see the 10 worst quarter in particular for equities and second quarter from 2022 was part of that list down 16% over the lookback that we actually have. And the average return that you have is about double what you would get if you looked at all potential periods. You would get the same thing about roughly on the bond side as well.

 

And if you put it together you know, one year later after the worst quarters for a 60/40, on average, you're up about five and a half percent, if you looked at all quarters. If you looked at the 10 worst quarters over that same period it's not on this chart, but I have the number in front of me. It's a 12.3% average. Now every period is unique. So doesn't mean that you're necessarily going to get there. There's a variety of returns that you can actually get. But the big picture is good things are happening underneath the surface, even if it doesn't feel like it. If you see periods of negative returns, it often sets you up for a period of positive returns looking forward.

Marc Zabicki:

Yeah, Barry, and the capital markets are a forward-looking mechanism, right? I think we've priced in quite a bit of bad news in terms of inflation and Federal Reserve and other central bank expectations. We talked about that. And we also know that typically interest rates peak prior to the Federal Reserve actually getting done with policy, you know, typically a six month variance there between the actual peak and when the Fed is done raising interest rates. We're around about that right now. So, you know, it's not an easy time to put money to work in equities or, or bonds. We understand that, but there are opportunities to head to in do exactly that. We touched on, we touched on some bond issues, some bond opportunities, and now here are some equity opportunities as well.

 

If we're correct in our base case from an asset allocation committee perspective, and inflation continues to trend down, the Federal Reserve perhaps has to do less hard work as a result of that. Perhaps other policy levers that may be pulled, that could improve things in a relative hurry. Not that we're expecting us to dramatically bounce back from a risky asset perspective, but we do think the opportunity is there given a pretty definitive oversold condition. So, Barry, last word today, on the Market Signals podcast, anything for investors to walk away with?

Barry Gilbert:

No, it's a pleasure to be on. I'll just reemphasize what you said. Markets are forward looking and often that means that all that they're looking for with the economy potentially turning is green shoots, right? They just need to see the beginning, things getting bad at a slower pace. That's often enough because that often tells you something about what's going to happen looking forward. And that's what we're going to be watching for if we see it, we'll tell you about it on the podcast.

Marc Zabicki:

Yeah, indeed, Barry I appreciate you joining me today, folks. Thanks for joining the Market Signals Podcast. It's a pleasure for us to be here, and we will check in with you next week.

Podcast Outro:

This material was provided by LPL Financial is for general information only, and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risk, including possible loss of principle. Any economic forecasts set forth in the podcast may not develop as predicted and are subject to change. References to markets, asset classes and sectors are generally regarding the corresponding market index. All indexes are unmanaged and cannot be invested into directly. Index performance is not indicative of the performance of any investment. All performance reference is historical and is no guarantee of future results. All information referenced in the podcast is believed to be from reliable sources, however, we make no representation as to its completeness or accuracy. Securities and advisory services offered through LPL Financial, a registered investment advisor and broker dealer member FINRA and SIPC insurance products are offered through LPL or its licensed affiliates.

 

To the extent you are receiving investment advice from a separately registered investment advisor, that is not an LPL affiliate. Please note, LPL makes no representation with respect to such entity. If your financial professional is located at a bank or credit union, please note that the bank or credit union is not registered as a broker dealer or investment advisor. These products and services are being offered through LPL or its affiliates, which are separate entities from, and not affiliates of the bank or credit union. Securities insurance offered through LPL or its affiliates are not insured by the FDIC or NCUA or any government agency, not bank or credit union, guaranteed not bank or credit union deposit or obligations, and may lose value.

Focused on Treasury Liquidity and Fixed-Income Opportunity

In the latest LPL Market Signals podcast, Director of LPL Research Marc Zabicki and Asset Allocation Strategist Barry Gilbert take a look at some measures that the Federal Reserve (Fed) and the Department of Treasury might take to address low Treasury liquidity. They also discuss current opportunities in fixed income markets and review the recent weak performance of a 60/40 portfolio of stocks and bonds and what may lie ahead.

Policymakers Looking at Ways to Address Weak Treasury Liquidity

Treasury market liquidity has become a major issue as the Fed raises rates and undertakes balance sheet runoff. Given the challenges, policymakers at both the Fed and Treasury Department are looking at ways to potentially improve Treasury market liquidity. The Fed is discussing temporarily excluding Treasuries from a key bank reserve ratio calculations, a move that may substantially increase Treasury demand. At the same time, the Treasury Department is discussing buying back “off the run” Treasuries, which would also likely improve liquidity. Better Treasury liquidity may add support to markets more broadly if it helps to contain interest rates and makes access to funding more efficient.

Rising Interest Rates Improve the Outlook for Bonds

Rising interest rates have created a challenging return environment for bond investors over the last year. At the same time, bond yields are the best predictor of bond returns over the next five years, and fixed income investors are looking at yields in many areas of the market that are now higher than at any point in the last decade or more. Central bank policy over the last decade had created a challenging environment for savers, but higher yields have improved the outlook substantially.

60/40 May Have Better Times Ahead

While it’s been a difficult environment for a 60/40 portfolio of stocks and bonds, the historical long-term drivers of returns for both have seen meaningful improvement over the last year. Bond yields have risen substantially and stock valuations have declined sharply, even if not yet cheap. LPL Research estimates that the combined effect may have raised the 10-year return outlook for a 60/40 portfolio by about 3 percentage points per year over the next decade compared to a year ago, even if near-term uncertainty continues.

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Listen to the entire podcast to get the LPL strategists’ views and insights on current market trends in the U.S. and global economies. To listen to previous podcasts go to Market Signals podcast. You can subscribe to Market Signals on iTunesGoogle Podcasts, or Spotify and find us on the LPL Research YouTube channel.

 


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IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth in the podcast may not develop as predicted and are subject to change.

References to markets, asset classes, and sectors are generally regarding the corresponding market index. All indexes are unmanaged and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

Stock investing includes risks, including fluctuating prices and loss of principal. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

High yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors.

Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the performance of 500 large companies listed on stock exchanges in the United States.

The Bloomberg U.S. Aggregate Bond Index, or the Agg, is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States.

All index data is from FactSet.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

This Research material was prepared by LPL Financial, LLC. 

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