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Written by: Jordan Jackson
Later this month will mark a year since the last rate hike from the Federal Reserve (Fed). Historically, the end of a hiking cycle should have been an opportune time to extend duration by deploying cash into high quality intermediate fixed income securities. In fact, over the last five policy cycles, the U.S. 10-year Treasury yield declined in every instance by 107 basis points on average during the period between the last hike and the first cut. However, at time of writing, the 10-year yield is 31 basis points higher than when the Fed last raised rates on July 26, 2023.
In hindsight, resilient growth and gradual cooling inflation over the past year explain this anomaly. While this has created a challenging backdrop for core bonds, a data-dependent Federal Reserve (Fed) may have enough evidence to feel comfortable reducing interest rates soon. We now expect the Fed to cut interest rates in September and December this year, followed by quarterly rate reductions through 2025. However, given this measured pace of rate cuts, investors are weighing the comfort of hanging out in cash with attractive yields or making an active bet on declining interest rates and investing further out the curve.
While it seems reasonable to continue to sit in cash, incoming data indicate growth and inflation should continue to normalize, and as the Fed reduces interest rates—albeit gradually—this should exert modest downward pressure on interest rates. It should also be emphasized that yields across high-quality fixed income remain attractive relative to recent history.
That said, we recognize the upside risk to interest rates given ballooning deficits and the potential for inflationary policies depending on the outcome of the November election. While these conflicting forces lead us to think long term interest rates will trade range bound in the near term, this doesn’t mean investors shouldn’t lock in attractive yields today. Of course, should rates decline even modestly, the longer duration the better. But even if rates remain broadly unchanged, as shown, even a small step out of cash into 2–3-year bonds should generate decent total returns over the next 12 months.
Overall, as the Fed begins cutting rates cash yields will fall. Therefore, the window to leg into duration may be closing suggesting investors would be wise to start putting their cash to work.
Impact of a 1% rise, fall or no change in interest rates
Total return, assumes a parallel shift in the yield curve
Source: Bloomberg, FactSet, Standard & Poor’s, U.S. Treasury, J.P. Morgan Asset Management. Sectors shown above are provided by Bloomberg unless otherwise noted and are represented by – U.S. Aggregate; MBS: U.S. Aggregate Securitized - MBS; IG Corporates: U.S. Corporates; Municipals: Muni Bond; High Yield: Corporate High Yield; Leveraged Loans: J.P. Morgan Leveraged Loan Index; TIPS: Treasury Inflation-Protected Securities; Convertibles: U.S. Convertibles Composite. Yield and return information based on bellwethers for Treasury securities. Past performance is not indicative of future results.
Data are as of July 16, 2024.
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