Bond yields have shown volatility throughout the year, prompting some experts to advocate for increasing fixed income exposure in portfolios.
Recent Treasury Auction
The recent $64 billion sale of five-year notes by the U.S. Treasury, the largest auction for this maturity, received tepid demand. Similarly, the $63 billion auction of two-year notes on the same day did not generate much excitement.
Yield Movement
With bond prices moving inversely to yields, the lackluster demand led to an increase in Treasury yields. The 10-year Treasury yield rose nearly four basis points to 4.3%, nearing its 2024 highs.
Investment Opportunity
Solita Marcelli, chief investment officer of the Americas for UBS Financial Services Global Wealth Management, sees this as a strategic opportunity. She suggests that investors take advantage of the recent yield movement, anticipating a further decline in yields and subsequent rise in bond prices.
Marcelli emphasizes that quality bonds remain a preferred choice in global portfolios, citing the potential for a 10% return for current holders of the 10-year Treasury if the yield drops to 3.5% by December.
Volatility and Rate Cuts
Market activity in the bond market has been turbulent as investors try to gauge when and by how much the Federal Reserve might reduce interest rates in response to inflation data.
Current indications from fed-funds futures suggest the likelihood of around three quarter-point rate cuts this year, aligning with both the Fed’s forecast and UBS’s outlook. Consequently, Marcelli advises investors to act promptly to secure current rates before they decrease.
Marcelli points out that the risk-reward profile for quality bonds is compelling at present, highlighting appealing yields and the potential for capital appreciation with expectations of receding inflation, slowing growth, and anticipated rate cuts by the Federal Reserve.
Even though yields have recently decreased from their peak, they still remain significantly higher compared to the pandemic period and have been at historically low levels for much of the past decade. While the allure of keeping cash in a high-yield savings account may be strong, Marcelli suggests that opting for high-quality bonds presents a wiser choice.
Benefits of High-Quality Bonds
According to Marcelli, high-quality bonds serve as an effective method for capital preservation, reducing volatility, and bringing stability to portfolios. They not only provide a reliable source of income but have also historically delivered superior returns compared to cash over the long haul. Remarkably, the odds of outperforming cash increase with prolonged holding durations—from a 65% chance over 12 months to 82%, 85%, and 90% over five, 10, and 20 years correspondingly.
The Sweet Spot: Five-Year Notes
Marcelli suggests that the sweet spot lies in five-year notes, offering a compelling blend of high yields, stability, and responsiveness to interest rate movements.
UBS Advocates for Bonds in Diversified Portfolios
UBS has previously asserted the importance of bonds in investors’ portfolios while acknowledging the challenging task of surpassing equities’ long-term return potential. Despite the S&P 500’s notable performance this year, with multiple record highs achieved since the beginning of 2024 following a substantial 24% surge last year, UBS advocates for diversification beyond equities.
LPL Financial Emphasizes Balanced Risk-Reward Outlook
Echoing the sentiment for diversification, LPL Financial recently reiterated its neutral stance on equities. The organization highlighted the improved economic growth and earnings outlook, coupled with stability in interest rates, which contributes to maintaining a fairly balanced risk-reward equilibrium between stocks and bonds.
Realistic Interest Rate Expectations
The outlook for interest rates appears more pragmatic now compared to late 2023 when excessive expectations of rate cuts were prevalent, with forecasts extending up to seven cuts in 2024—far exceeding the Fed’s projections. As these ambitious anticipations have tempered down, the bond market is expected to experience reduced volatility as it aligns its rate-cut predictions with those of the Fed.
Diverse Perspectives on Investment Strategies
While some influential figures like Warren Buffett from Berkshire Hathaway continue to favor cash and stocks, advocating for a diverse range of investment strategies is essential in navigating the dynamic market landscape.
Inquiries can be directed to Teresa Rivas.
