Midyear Fixed Income Outlook Masterclass

As we pass the midpoint of 2024, the fixed income market stands at a critical juncture, influenced by macroeconomic factors, political uncertainties, and evolving investor behavior. Recently, experts from TCW , Allspring Global Investments , and Bartlett Wealth Management gathered to share their insights during the Mid-Year Fixed Income Outlook Masterclass, offering a comprehensive view of what lies ahead. Below are some of the key takeaways that every investment professional should consider.

Politics and the Fixed Income Markets

The discussion kicked off with a focus on the potential outcomes of the upcoming U.S. elections and their impact on bond markets. As Ruben Hovhannisyan , Generalist Portfolio Manager at TCW, aptly noted, "You can expect two outcomes. One is a divided government with a Republican president and Democrats in Congress or vice versa. In that kind of outcome, you should expect more or less status quo." This status quo, in Ruben’s view, suggests lower yields and a steeper curve.

However, the scenario shifts significantly under a unified government. "If Democrats win both, the spending policies will probably be stronger or a little more extreme... That will put pressure on the longer end of the curve in terms of yield premiums," Ruben explained. On the other hand, if Republicans control both the presidency and Congress, "The curve will probably be steeper with a lower front end and a higher long end."

For investors, these scenarios raise several critical questions: How should portfolio strategies be adjusted in anticipation of potential shifts in government control? What strategies can be employed to hedge against the risks associated with increased government spending and rising inflation? And how can investors prepare for the possibility of a steeper yield curve, regardless of which party holds power?

Opportunities for Tax-Sensitive Investors

For tax-sensitive investors, particularly those in higher tax brackets, municipal bonds remain a central focus. Christopher D. Robbins, CFA , Investment Advisor and Fixed Income Portfolio Manager at Bartlett Wealth Management, emphasized that "the yields on munis, if you compare them to Treasurys, are close to 70% of the yield you can get on a Treasury." This, he suggests, is a reasonable deal after tax, particularly in a landscape where credit quality remains robust.

However, Chris also encouraged investors to look beyond munis. "It's okay to look at bonds that aren't munis because after-tax, even short-maturity, high-quality corporate bonds can still be attractive," he said.

Inflation, Liquidity, and the Need for Nimbleness

At the macro level, inflation remains the dominant theme in 2024. George Bory , Chief Investment Strategist for the Fixed Income team at Allspring Global Investments, highlighted that "inflation is the dominant theme... The big assumption in markets is that inflation is going to decelerate from here in an orderly fashion and ultimately get close to policy targets." But what if inflation takes an unexpected turn? "Financial securities are not a good hedge against unexpected inflation shocks," George warned.

Beyond inflation, the discourse gravitated towards the often-underappreciated facet of liquidity. George emphasized its paramount importance,

"Liquidity is kind of the lifeblood of a bond portfolio, and we think that you need to have enough income in the portfolio to perform and then enough liquidity in the portfolio to be nimble to be able to navigate as we go through this path."

Ruben Hovhannisyan echoed this sentiment, pointing out that "liquidity is a factor that sometimes doesn’t get the attention it deserves... It's another source of generating alpha for the portfolio." He further elaborated on the strategic advantages of maintaining liquidity,

"Being able and having liquidity to deploy capital at the time of dislocation and volatility, where you can add securities and sectors to the portfolio at prices that are far cheaper than the intrinsic valuations that are warranted for the sectors and securities."

In tandem with liquidity, the need for nimbleness in portfolio management emerged as a recurrent theme. George underscored the value of adaptability,

"Nimbleness and liquidity I think is critical at this point in the cycle. If you do that well, your portfolio is going to be just fine. And those income streams that we're setting up today really should be very predictable and very realizable, not just over the next six months, but over the next several years."

Sharpening the Pencil on Security Selection

The current environment, characterized by higher inflation and political uncertainty, demands precision in security selection. "This is a time to sharpen the pencil and be very, very selective in terms of securities issuers that you're adding to your portfolio," Ruben advised. In periods of market volatility, the risk of decompression in spreads for weaker issuers is heightened, leading to potential losses.

Final Thoughts

The fixed income market is fraught with challenges, but it also offers substantial opportunities for those who remain vigilant and adaptable. From the potential impacts of the U.S. elections to the importance of liquidity and careful security selection, there is much to consider.

As George Bory aptly put it, "If you do that well, your portfolio is going to be just fine... Not just over the next six months, but over the next several years."

What steps will you take to ensure your fixed income portfolio is positioned for success in this evolving landscape? The decisions you make today will have a lasting impact on your portfolio's performance in the years to come.