How to invest in fixed income in 2015Contributor Dr. David Kelly
It’s never easy to prognosticate the markets.
But the behavior of the major central banks in the year ahead is likely to make forecasting particularly difficult. There is simply no prior example in global financial history in which central banks have so deliberately distorted financial markets.
But with that caveat in mind, there is a logical starting point for any global asset allocation discussion. This column shares our thoughts on how to invest in fixed income in 2015.
Fixed income outlook
Although the Fed could start raising short-term rates as early as March 2015, it is more likely to do so in June 2015, given inevitable bouts of volatility, still low inflation and the dovish composition of the Fed. Either way, once the Fed starts, it will likely keep going, as a first rate increase in June followed by a quarter of a percentage point increase in rates in every subsequent meeting would still only get rates to the Fed’s long-term target of 3.75% by early 2017. At that point, the unemployment rate, given current trends, could be at a highly inflationary sub-4% level. Long-term Treasury rates will likely move higher as the Fed begins to tighten. We expect 10-year Treasury yields to increase to over 3.0% by the end of 2015 and to close to 4.0% by the end of 2016.
Impact on fixed income sectors
- Such a scenario implies negative total returns along the entire Treasury yield curve for maturities of two years and above over the course of 2015. Consequently, 2015 should be a year to be underweight Treasuries and short duration in the U.S.
- Treasury Inflation Protected Securities (TIPS) are also likely to provide negative returns in 2015 since the increase in nominal Treasury yields is likely to come from higher real yields rather than higher inflation.
- Corporate bonds may outperform Treasuries in an improving economy with rising Treasury rates. As shown in the chart, high yield and high quality corporate bond spreads are at close to average levels and their higher coupons relative to Treasuries should insulate them somewhat from the impact of higher interest rates.