We expect equities to outperform bonds this year as moderate economic growth continues, with no recession imminent, in our view. However, political and other uncertainties could drive volatility higher, highlighting the stabilizing role fixed-income investments typically play during market pullbacks.
Long-term rates to rise modestly – Last year’s sizable decline in long-term interest rates reflected recession fears, a global slowdown and expectations of a Federal Reserve policy shift. With global growth showing signs of stabiliza-tion, trade tensions easing and market expectations more aligned with current monetary policy, the 10-year Treasury yield is not likely to fall materially below 2%, in our view. We think bond yields will rise modestly, with accommodative central bank policies and slow growth continuing to act as anchors.
Fed on pause through 2020 – Last year, the Fed cut interest rates three times as insurance against recession risks. As a result, financial conditions eased substantially, and recession fears receded. We believe the bar for the Fed to either lower or raise interest rates is set very high leading up to the 2020 election. Improving economic data and lower risk of a further slowdown in global growth should mean no further rate cuts are needed. At the same time, inflation is running stubbornly below the Fed’s target, providing flexibility to remain accommodative without having to raise rates.
Policy remains a tailwind – Monetary policy changes impact the real economy with a lag of typically six to nine months. Therefore, we expect the markets and the economy to continue to benefit from last year’s interest rate cuts. The housing sector, which is sensitive to interest rates and Fed policy, has recently strengthened, adding to economic growth last quarter for the first time since late 2017.
Despite ongoing low yields, we still think fixed-income investments play an important part in portfolios. We recommend an appropriate allocation to bonds, including U.S. investment-grade, high-yield and international bonds.
Before investing in bonds, you should understand the risks involved, including credit risk and market risk. Bond investments are also subject to interest rate risk such that when interest rates rise, the prices of bonds can decrease, and the investor can lose principal value if the investment is sold prior to maturity.
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