As the second half of the year unfolds, fixed-income investors are urged to assess their portfolios and make necessary adjustments. Initially, there were expectations of multiple interest rate cuts by the Federal Reserve in 2019. However, the Fed has maintained the federal funds rate at the range of 5.25% to 5.50%. There is a growing anticipation that the central bank may start reducing rates in the coming months, potentially commencing as early as September.
The decision to cut rates is driven by a combination of factors including falling inflation rates and a cooling labor market. Chief fixed-income strategist at Charles Schwab, Kathy Jones, pointed out that both price data and the jobs market are aligning with the Fed’s objectives. Real interest rates are on the higher side after accounting for inflation. Jones foresees improved returns for fixed income in the latter half of the year but warns about heightened volatility in the market.
In the current economic climate, Jones suggests considering adding duration to the portfolio by venturing into longer maturities. While Treasurys remain a fundamental component, limited potential gains exist due to the inverted yield curve. Alternative options like investment-grade corporate bonds and government agency mortgage-backed securities in the six- to seven-year range provide attractive yields with minimal credit risk. By diversifying between Treasurys and these fixed-income asset classes, investors can create a balanced barbell portfolio or opt for a bond ladder strategy to capitalize on potential price appreciation.
JPMorgan advocates for a barbell approach, expecting the curve to remain inverted till the close of 2024. While foreseeing the possibility of a positively sloped curve by the end of 2025, the bank recommends extending duration gradually to maximize returns amidst changes in monetary policy and economic growth. Embracing a barbell strategy could prove beneficial for investors by earning attractive yields at the front end while mitigating risk with a diversified duration portfolio. Wells Fargo recommends prioritizing credit quality as the yield curve stays inverted for the next 6 to 18 months. Municipal bonds and high-quality securitized products like residential mortgage-backed securities are favored by Wells Fargo due to their relative value compared to investment-grade corporates.
Considering the ongoing discussions about deficits and fiscal responsibility, Wells Fargo highlights the significance of investing in municipal bonds, especially for individuals in higher tax brackets. Muni bonds exempt from federal taxes can offer a favorable investment opportunity. Given the uncertainty surrounding future tax adjustments for fiscal discipline, allocating funds to state and local general obligation bonds and essential service revenue bonds could prove to be a judicious move.
By strategically rebalancing fixed-income portfolios based on prevailing economic indicators and market forecasts, investors can position themselves to maximize returns and mitigate potential risks in the latter half of the year. As the financial landscape evolves, staying vigilant and adaptable to changing circumstances will be crucial for achieving long-term investment goals.