Same as it ever was Same as it ever was

Same as it ever was

Inflation and rates may rise, but a surge is unlikely.
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If you graduated from high school or college in the 1980s or simply are a fan of pop music, the title of this piece probably brings to mind the Talking Heads song, “Once in a Lifetime.” Music is a mnemonic device: You hear a tune and memories from a prior period in your life come flooding back. But while the big hair of the 1980s has disappeared and interest rates are decidedly lower, when it comes to the role of fixed income in your asset allocation, it’s the same as it ever was.

That may not be what you’ve been reading or hearing as of late. According to many of the talking heads in the popular media, a prolonged secular bull in global bond markets is coming to an end, with the current backup in long U.S. rates offering a rare opportunity to cash in those profits before rates shoot up. But the reality for the vast majority of retail investors is that fixed-income has never been about making a lot of money. Yes, fixed-income is a vehicle for generating capital gains. But that attribute diminishes as interest rates approach or exceed zero-bound (i.e., go negative, as occurred in recent years in some countries). At its core, fixed income serves as a vehicle for saving and preserving capital. It’s a type of portfolio insurance for the diversified investor.

When it comes to asset allocation, fixed-income has three primary missions. First, it generates a known income stream. Second, it lowers portfolio volatility (by virtue of the known attributes of the income stream and the contractual obligation to return principal). And third, it’s a hedge against deflationary episodes in the global economy, such as those experienced in the late 19th century, the 1930s, 2008-09 and even the first quarter of 2016. These objectives don’t change over time, regardless of the level of interest rates.

If traditional economic modeling behavior holds, generational lows in unemployment, growing U.S. and global debt levels, and unprecedented central bank intervention may conspire to prop up prices. But at the same time, aging global demographics, increased linkages via trade and finance, and ongoing efficiencies brought on technology continue to act as powerful countervailing forces. So inflation and rates may rise, but surge? Unlikely. Put another way, though the opportunity for capital gains may be narrowing, the reason for investing in fixed-income remains the same as it ever was.

Tags Fixed Income Active Management Fiduciary Income

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Asset allocation does not assure a profit nor protect against loss.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Federated Investment Management Company