General
- Long-term yields have tended to peak before the Federal Reserve (Fed) finishes raising rates. We favor remaining nimble in bond portfolio allocations with a barbell strategy that lengthens maturities but can also take advantage of ultra-short-term yields.
- We expect high-quality bonds to provide support to investment portfolios during periods of equity market volatility. In 2023 bonds managed to recover slightly and add to portfolio returns.
Domestic
- Bond yields moved lower across the yield curve during the fourth quarter as investors began to anticipate Fed rate cuts in 2024. The yield curve, however, remained inverted (it has been so since July 2022) as short-term rates have remained higher than intermediate- and long-term rates.
- We believe the Fed has softened its stance toward further hikes and most likely has reached its terminal policy rate for this cycle. The Fed surprised markets with a dovish tilt at its December 2023 meeting, with the dot plot implying three potential rate cuts in 2024.
- Credit spreads continued to narrow further during the fourth quarter of 2023 as credit conditions eased. However, the risk is for further widening as financial conditions tighten during an economic slowdown in the first half of 2024.
International
- Yields traded within a relatively narrow range at higher levels, as markets looked for the end of the rate-hike cycle, constrained by easing inflation expectations but still-hawkish rhetoric from many central banks.
- We expect the European Central Bank to keep policy interest rates on hold near 4.00% in the first quarter. Eurozone bond yields may peak before the end of the hiking cycle, as a recession looms.
- Emerging market (JP Morgan EMBI Global Index) spreads also narrowed in the fourth quarter. Index yields dropped driven by the decline in U.S. Treasury rates. Higher relative yields should attract inflows once we see a clearer turn in U.S. interest rates and the dollar.