Core Fixed Income: Down but Not Out

Lawrence Gillum | Chief Fixed Income Strategist

Last Updated: February 29, 2024

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.

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. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.

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Indexes are unmanaged and cannot be invested into directly. Index performance is not indicative of the performance of any investment and does not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.

This material was prepared by LPL Financial, LLC. All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.

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Asset Class Disclosures –

International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.

Bonds are subject to market and interest rate risk if sold prior to maturity.

Municipal bonds are subject and market and interest rate risk and potentially capital gains tax if sold prior to maturity. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply.

Preferred stock dividends are paid at the discretion of the issuing company. Preferred stocks are subject to interest rate and credit risk. They may be subject to a call features.

Alternative investments may not be suitable for all investors and involve special risks such as leveraging the investment, potential adverse market forces, regulatory changes and potentially illiquidity. The strategies employed in the management of alternative investments may accelerate the velocity of potential losses.

Mortgage backed securities are subject to credit, default, prepayment, extension, market and interest rate risk.

High yield/junk bonds (grade BB or below) are below 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.

Precious metal investing involves greater fluctuation and potential for losses.

The fast price swings of commodities will result in significant volatility in an investor's holdings.

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Lawrence Gillum

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