2020 Mid-Year Outlook: Fixed Income

Returns for most fixed income asset classes are positive so far this year, but the numbers mask the rocky road markets have traveled since January.

Thanks in large part to the Federal Reserve’s decision to slash interest rates in response to the economic lockdown as the COVID-19 crisis spread, bonds with the least risk, like Treasuries, have posted the strongest returns, while returns for riskier segments of the market are slightly negative.

Fixed income asset class total returns, year-to-date

Source: Bloomberg. Returns from 12/31/2018 through 6/15/2020. Indexes representing the investment types are: Long-term core = Bloomberg Barclays U.S. Aggregate 10+ Years Bond Index; Treasuries = Bloomberg Barclays U.S. Treasury Index; Intermediate-term core = Bloomberg Barclays U.S. Aggregate 5-7 Years Bond Index; US Aggregate = Bloomberg Barclays U.S. Aggregate Index; Investment Grade Corporates = Bloomberg Barclays U.S. Corporate Bond Index; Short-term core = Bloomberg Barclays U.S. Aggregate 1-3 Years Bond Index; Municipals = Bloomberg Barclays US Municipal Bond Index; Int. developed (x-USD) = Bloomberg Barclays Global Aggregate ex-USD Bond Index; Emerging Market = Bloomberg Barclays Emerging Markets USD Aggregate Bond Index; Preferreds = ICE BofA Merrill Lynch Fixed Rate Preferred Securities Index; S&P 500 = S&P 500 Total Return Index (SPXT); HY Corporates = Bloomberg Barclays US High Yield Very Liquid (VLI) Index. Returns assume reinvestment of interest and capital gains. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

Bridging the economic gap to the new normal

Although returns have been generally positive, yields have swung widely as markets reacted to the sudden halt in economic growth, the Fed’s rapid rate cuts and fiscal stimulus, followed by nascent signs of recovery. For a few brief days in March, short-term Treasury yields were even negative, while high-yield (or “junk”) bond yields soared by more than 600 basis points (or six percentage points) relative to Treasury yields.1

All of this volatility reflects the markets’ efforts to find a path through the economic downturn to the new normal. An enormous gap has opened up between the potential growth rate in the economy and actual growth rate. The gap represents the lost output of goods and services. It signals excess capacity in the economy and tends to put downward pressure on inflation. The Federal Reserve and Congress have tried to fill the gap with direct funds to households and loans to businesses.

Gross domestic product is running below potential, suggesting inflation is not a near-term threat

Source: U.S. Bureau of Economic Analysis and U.S. Congressional Budget Office. Nominal Potential Gross Domestic Product (NGDPPOT), Gross Domestic Product, and the Gross Domestic Product Forecast. Quarterly data as of Q1-2020 with forecast through Q4-2020.