Fed pivot should create multiple tailwinds for fixed income

Current market conditions are attractive for fixed-income investing, says Siena Sheldon, vice president, client portfolio manager with Brandywine Global Investment Management.

Speaking on the latest episode of the Soundbites podcast, Sheldon described several bond-positive tailwinds, including inflation’s ongoing decline, expected rate-cuts from the Federal Reserve, and attractive starting yields and coupons.

“Investors that are still underweight fixed income should reconsider increasing their allocation at this point,” she said.

She said exposure to U.S. Treasury duration is warranted, given that we appear to have reached peak rates.

“That presents a good total return opportunity,” she said. “We have balanced this with some shorter-duration, higher-quality, high yield in our multi sector strategies.”

She also likes high-end corporate credit, which boasts good starting yields, even on the front end of the curve. She cautioned, however, that not all bonds are equally attractive.

“You want a portfolio manager that is doing the bottom-up work, choosing credits with good fundamentals, avoiding any defaults, and not going too far down in quality,” she said. “We are conscious that spreads are tight, but absent any real recession, any spread widening is largely cushioned by that great starting yield.”

Sheldon said she’s expecting a significant rate cut when the Fed meets next week, due to deteriorating jobs figures in recent weeks.

“The Fed has a tough balancing act with a dual mandate of full employment and bringing inflation down, and they will certainly need to start cutting here to ensure they keep that full employment promise,” she said.

The initial cut could be as much as 50 basis points, she said, and more cuts are expected.

“That rate cut is already being priced in, with some market pricing in not only that September rate cut, but around six to eight rate cuts in the next 12 months,” she said. “Ten-year yields have come down significantly in the last month, and, in fact, we’re back at December 2023 lows in yields.”

As for equities, she expects recent volatility to calm down as long as the Fed is able to avoid any recession scenario.

“Although we are expecting some sort of growth slowdown in the U.S., our base case is not a recession at this point,” she said. “Our growth outlook in the U.S. is one of cautious optimism.”

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This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.