Core Fixed Income: Down but Not Out

Lawrence Gillum | Chief Fixed Income Strategist

Last Updated:

Additional content provided by Colby Hesson, Analyst, Research

The Federal Open Market Committee (FOMC) faces a tough decision in 2024 as it is no longer a question of ‘if,’ but rather ‘when’ rate cuts will occur. The FOMC is not expected to cut rates at their upcoming March meeting, but according to recent market pricing, may instead opt for a rate cut in June. Since their last meeting in January, surprisingly elevated inflation readings have cast a shadow of doubt over those expectations. Premature rate cuts from the Federal Reserve (Fed) risk reigniting inflation, which they have been diligently trying to bring down to 2%. Even if rate cuts get priced out again, we expect fixed income to still provide utility to portfolios. 

Treasury yields have generally increased over the last month, while the Bloomberg Aggregate Bond Index (AGG) has declined by nearly -0.30%. However, we think yields could fall to the high 3s, potentially resulting in high-single-digit returns for core bonds. Moreover, reviewing the Hypothetical Returns table, while we think yields will end the year below current levels, even if rates rise, many core fixed income sectors are still likely to eke out positive returns.  

Hypothetical Returns: Interest Rate Scenario Analysis

 

Change In Interest Rates

Index

-1.0%

-0.5%

No Change

+0.5%

+1.0%

Bloomberg US Aggregate Bond Index

11.8%

8.9%

4.9%

3.2%

0.3%

Bloomberg MBS Index

12.6%

9.8%

5.1%

4.1%

1.2%

Bloomberg US Treasury Index

11.0%

8.2%

4.5%

2.6%

-0.1%

Bloomberg US Corporate Index

12.7%

9.5%

5.4%

3.0%

-0.2%

Bloomberg Intermediate Corp Index

9.3%

7.6%

5.3%

4.1%

2.3%

Bloomberg US High Yield Corporate Index*

10.0%

8.7%

6.2%

6.0%

4.6%

*Assumes 3% default rate and 30% recovery rate.
Source: LPL Research, Bloomberg 02/23/24
Disclosures: Past performance is no guarantee of future results. All indexes are unmanaged and can’t be invested in directly.

Conclusion

The market got ahead of itself late last year in pricing in aggressive rate cuts, so the back-up in yields is warranted, in our view.  Starting yields for many fixed income markets are still at levels last seen over a decade ago, so the return prospects for fixed income remain favorable as well, in our view. However, increased Treasury supply in the coming quarters could exert upward pressure on yields. And while we do not expect the Fed to cut rates in March, we still expect cuts this year. As such, our year-end 2024 range for the 10-year Treasury yield remains 3.75% to 4.25%, and we expect fixed income to outperform cash in 2024. 

Lawrence Gillum

Lawrence Gillum, CFA, guides the fixed income view for LPL Financial Research and has over 20 years of investing experience.