Doug Drabik discusses fixed income market conditions and offers insight for bond investors.
Hastily, investors have turned their worry about inflation into worry about a recession. The catalyst was Friday’s unexpectedly disappointing unemployment number. Recall that the Fed maintains two prime mandates of maintaining stable prices and maximizing employment. Inflation has been a major focus since peaking at 9.2% in mid-2022. The Fed has been focused on bringing it closer to its 2% target. Inflation has dropped dramatically but despite the improvement, Personal Consumption Expenditure (PCE) sits at 2.63% and Consumer Price Index (CPI) sits at 3%, both data points are well above the ultimate target level.
Falling inflation does not mean that prices are dropping but rather indicates that prices are not increasing at quite as high a rate. The increased costs of food, housing, and staple goods remain elevated and continue to rise. At the same time, household savings have decreased, and borrowing (debt) has increased. Consumers appear to be tapped out. This formula, now substantiated by diminishing labor market data, has investors alarmed. A Fed move of 25 basis points (bp) or even 100 bp may not be enough to stimulate the economy.
Investors that have saved have benefitted from the high interest rate environment. Even non-investors have benefitted from lofty bank savings rates and money market rates. With the market tone turning, those who have not locked in for longer have not missed the opportunity but are now likely missing the opportunity. For the last 6-12 months, the market has lulled us into believing or expecting higher levels of interest as the norm. It is easy to forget that the primary purpose for many fixed income investors is protecting the principal. Our latest investing period has allowed investors to not only protect the principal but as a secondary benefit, to also lock into high income.
We are not through. The existing opportunity may compel investors, especially retirees or those approaching retirement, into action. Many fixed income products still allow investors to lock into rates north of 4%, a realistic and prosperous goal for the portfolio allocation dedicated to preserving one’s wealth. High short-term rates associated with money markets and savings are going to fade away if the Fed takes action and begins cutting interest rates. The inverted Treasury curve is narrowing. The 2-year Treasury rate was 158 bp higher than the 10-year Treasury rate in March of 2021. This morning the difference between the 2- and 10-year Treasury rates is hovering around 0 bp after being inverted for over two years.
The pressure on interest rates is also affecting the stock market. Expect high volatility as continued panic and more uncertainty ensue. Fixed income will continue to provide a means to wealth preservation and stable income. Income is still not only available but will provide a known performance through this market volatility.
