Navigating fixed income through Fed policy shifts

CONTRIBUTORS

Christy Tan

Investment Strategist
Franklin Templeton Institute

Lukasz Labedzki, CFA

Senior Analyst
Franklin Templeton Institute

Preview:

This report leverages the Franklin Templeton Institute's US Fixed Income Navigator (FIN) to analyze historical data and provide insights on managing fixed income portfolios amidst Federal Reserve policy changes. European fixed income trends are also explored.

Fourth quarter (Q4) 2024 highlights

In Q4 2024, our model-based conviction has further strengthened, highlighting a more constructive balance of risks and opportunities for bonds.

Exhibit 1: US Fixed Income Navigator Dashboard (LYVFE signals)

Franklin Templeton Institute, August 2024 Update.

Yields in the fixed income space remain historically attractive across the board, especially in real terms, as inflation expectations have eased and are anchored around 2%. Additionally, progress on inflation and slowing global economic momentum (evidenced by the recent drop in commodity prices) have led markets to widely expect the interest rate cut that the Fed implemented in September, driving a bull steepening of the yield curve—a favorable environment for high-quality bonds.

A key short-term risk is that much is already priced in, meaning more pronounced surprises are needed to outperform historical averages. Longer-term risks include rising geopolitical tensions, which could complicate inflation control, and growing fiscal deficits that may demand higher premiums for US government bonds.

In this piece , we explore the impact of past interest-rate-cutting cycles on fixed income portfolios and share key historical lessons that we believe remain relevant today.

WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal.

Equity securities are subject to price fluctuation and possible loss of principal.

Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.

International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility.

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