As expected, the Federal Open Market Committee (FOMC) voted to leave short -term policy rates unchanged at 5.50% at its June meeting. The Fed acknowledged “modest further progress” on inflation but is not quite ready to cut rates. We expect the Fed to keep interest rates at current levels for most of this year. For investors, that means cash yields will remain elevated. But there is also a risk to holding too much cash. Fixed income markets are priced to assume that rates will fall next year. For this reason, we are taking advantage of opportunities to move out of cash and into short and intermediate term bonds. Doing so allows us to “lock in” relatively attractive yields for the next few years without having to take on too much price duration or “price risk.”
In addition to income or “yield,” bonds offer a diversification benefit to portfolios. This is especially relevant today compared to periods when bond yields were very low, which was the case just a few years ago. So, diversification is another reason we have been moving some money out of cash and alternative (“other”) asset classes and into bonds. If the equity market corrects, we expect bonds to hold up relatively well and offer some portfolio protection as well as income.
Finally, though the market has been reacting with some level of complacency about the level of U.S. government indebtedness, we have not turned a blind eye to this concern. At some point in time, Congress will need to address the current unsustainable levels of government debt relative to GDP. This could involve an adjustment to certain entitlement programs (e.g. Medicare, Medicaid), a reduction in spending, and higher taxes. We have managed this risk by owning high quality corporate and municipal bonds and bond funds/ETFs at relatively short maturities, which are less sensitive to long term borrowing costs.
