December 2023
The Federal Reserve (the Fed) raised interest rates multiple times in 2023 – greatly impacting bond yields. Eric Hundahl, BNY Mellon Investment Management Head of Portfolio Strategy, says turning to longer-dated bonds could benefit investors.
Highlights
- We believe the door is wide open for the Fed and other central banks to cut rates in 2024
- Longer maturity bonds may yield higher returns than shorter maturity bonds in 2024
- Stock / Bond correlations need to normalize for long-term bonds to be advantageous for balanced portfolios
Some viewed cash as king in 2023 thanks to numerous interest rate hikes, but many believe the Fed is unlikely to raise rates much further – creating an environment where investors may realize higher returns from longer-dated bonds.
“One of the surprises of this year was the rapid rise in interest rates, particularly on the back end of the curve, largely driven by supply and demand dynamics at the Treasury,” says Eric Hundahl, BNY Mellon Investment Management Head of Portfolio Strategy. “I do think it will present an opportunity for investors that were largely sitting in cash to extend duration, to move further out on the curve at the end of this year (2023) and then going into 2024.”
3 Hurdles to fixed income
The yield curve is expected to normalize in 2024, with longer maturity bonds yielding higher returns than shorter maturity bonds. However, there are some hurdles investors will need to overcome before this happens.
- Confidence the Fed’s ability to deliver on its own projections of rates
- Rate volatility needs to come down
- Improved stock/bond correlation
“We just don't need upward pressure for the Fed to be done, but we actually need rate volatility to come down,” says Hundahl. “Bonds really haven't been an effective hedge to the equity risk in portfolios this year as the stock/bond correlation has been too high.” Furthermore, Hundahl notes, “We think investors should start thinking about, if they haven't already, is increasing duration in their balanced portfolios.”
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