Fixed Income Q4 2023

Following a difficult year in 2022, the bond market rebounded in 2023. As the year progressed, the Fed finally paused its aggressive rate hiking campaign and appears set to ease in the year ahead.  Long-term interest rates eased along with inflation, with the 10-year Treasury note falling from a peak of 5.0% last year to 3.8% in December. The growing fiscal deficit poses a challenge, as it will need to be funded with increased issuance of government bonds in the years ahead. Corporate borrowers will also need to refinance debt at borrowing costs that remain elevated. The Fed could provide surprises to the fixed income markets if they fail to cut rates as much as the market is currently forecasting. Despite these factors, we are finally seeing attractive real returns (i.e. adjusted for inflation) on fixed income (generally above 5%) without having to assume much duration risk.  For this reason, our investments have been generally focused on the short and intermediate maturity spectrum, and our cash allocations are higher than they have been in recent years.  While cash is still the best investment for short-term needs, we advise “locking in” higher yields by owning a mix of short-term bonds or bond ETFs. Corporate bonds still look attractive over the intermediate term, although credit spreads (i.e. the additional yield for assuming credit risk) for both high grade and speculative (high yield) bonds are relatively tight. High quality municipal bonds are also an attractive investment option for taxable investors, given fiscal conditions at the state and local levels. In summary, we expect favorable conditions in the bond market to continue with reasonable yields, stable credit, and the potential for some price improvements assuming interest rates fall in the year ahead.