Since March of this year, the Federal Reserve has steadily increased the Fed Funds rate over 5 consecutive meetings. The rate hikes started modestly in March and May with 0.25% and 0.5% hikes, respectively. In the latest 3 meetings, the Fed hiked at a historic pace of 0.75% each, which puts the current Fed Funds Rate at 3.25%. During the last Fed Reserve Meeting, the Fed Chairman expressed the need to continue raising interest rates to battle inflation. Even though the annualized inflation rate had peaked in June at 9.1% Year-over-Year, the month-over-month inflation data in August was hotter than expected. This emboldened the Fed to double down on their hawkish tone, signaling that they would like to increase rates by another 1.25% before the end of the year and to leave them at those elevated levels through 2023 until they are convinced that CPI is on a downward trend.

Two years ago, in the midst of Covid, the Fed Reserve cut interest rates drastically to almost zero in order to boost the slowing economy. At the lows, the 10 Year Treasury Yield sat at 0.31%. With the rapid interest rate increases and promises for further hikes, the 10 Year Yield currently sits at 3.95%.  Although this may seem shockingly high, investors should be reminded that treasury yields held around the 4% level for the better part of the early 2000s. Therefore, this is far from uncharted territory. That being said, momentum indicators like the “RSI”signal that the rise in yields appears overdone, and market technicians at RBC Capital Markets note that investors could see a peak in yields by the next quarter. Although we do not expect yields to fall back to cycle lows, we feel it is reasonable to expect yields to drift lower. One reason this could happen is if the next few months of CPI data show cooling inflation, which should reduce the need for the Fed to recalibrate their interest rate targets higher. When the market perceives that the Fed is nearing the end of their hiking cycle, yields should subside. Another reason could simply be because higher yields attract more bond investors. With heightened demand, market dynamics lower the yields to test the appetite for bonds. Given that yields are markedly higher relative to recent history, investors may be willing to buy these bonds even if the yield is lowered. More buying at lower yields begets lower yields. Famed investors like Jeffrey Gundlach stated last week that the bond market is the most attractive in years and that he is buying Treasury yields.

As bond yields fall, the prices of bonds increase. This relationship is best illustrated by imagining yourself owning a bond that pays 4.5%. If in the following month, market yields fall to 3.5%, then the bond that you previously purchased looks relatively more attractive and should demand a higher price. Hence, in the scenario where yields drift lower, bond investing becomes more attractive. In the past, bonds yielded a fraction of a percent and could fall in price due to expected rising yields. Today, bonds provide 3-5% income with the potential for price gains.

A quick google search of “The Death of 60/40” brings upon countless results. This was understandable as holding 40% of your money in bonds became a tremendous drag to a portfolio due to low yields and the likelihood of losses. However, we feel the current setup for a traditional 60/40 portfolio (i.e. 60% equity, 40% bonds) has become attractive again. Going forward, this 40% of the portfolio can be extremely productive with higher yields and price gains. The remaining 60% in equities are also being held or purchased during recessionary-like levels. Historically, average returns recovering from these depressed levels can average 20% or more in gains. Therefore, what once seemed to be an anemic and unattractive portfolio may soon re-enter the spotlight with forward expected returns that will outmatch anything that we have seen in recent memory. Speak to your advisor about rebalancing your portfolio and whether you are taking advantage of the current higher yield environment.