SUMMARY
Intermediate rates on high quality bonds may be near a peak, as inflation abates and employment softens. Suitable investors might switch cash into various bonds with average duration of 5 years.
We think investors may earn higher for longer
- US Treasury yields have moved to multi-decade highs. These are the highest yields since the mid-2000s and are near 80% of their maximum yield since 1998.
- Real yields – what an investor earns after inflation – are also near 80% of their maximum yield since TIPS were first introduced back in 1997.
- We expect Inflation to slow to 2.5% by year-end 2024 and so does the Fed. We also think that employment growth will slow and unemployment in the US will rise modestly next year. This could likely lead to the Federal Reserve to cut interest rates to avoid a recession. It would also likely result in lower intermediate bond yields.
- We believe current yields on high quality bonds provide a compelling potential opportunity to lock-in durable portfolio income for many years.
The potential opportunity from higher yields
US Treasury yields extended their August “bear steepening” trends as yields surged in September and October. The 10-year yield set a multi-decade high above 5% this past week, before settling back down. With yields across the curve at very high levels relative to the past 15 years and even a few months back.
What to consider
We believe that intermediate rates are at or near their peak. While US growth measures rebounded in 3Q, we see sufficient tightening from the Fed to believe that inflation is abating, US employment will slow, and supply and demand equilibrium is being reached broadly across the US.
At some point in 2024, we believe the Fed will change its focus to sustaining employment gains rather than forcing them down.
We therefore suggest that suitable investors move from cash to a variety of intermediate-duration bonds with an average duration of 5 years. Not only will this lock in high real yields, but it will add meaningful core income in suitable portfolios. We do not think that these rates will remain at current levels for years to come. In 2024, we can imagine intermediate rates moving lower as economic events unfold.
It important to note, bonds are affected by a number of risks, including fluctuations in interest rates, credit risk and prepayment risk.
