The recent turmoil in the bond market, which began in October, was one of the most severe sell-offs in history. However, as 2023 draws to a close, Chief Fixed Income Strategist for LPL Financial Lawrence Gillum believes there is cause for optimism in the fixed-income market heading into the new year.
Gillum highlighted five reasons why the current setup looks promising for investors. First, he noted that bonds have only recently turned positive for the year, marking a recovery from the recent rout. Additionally, he suggested that the Federal Reserve’s likely decision to halt rate hikes should eliminate the biggest challenge for bond investors.
“The biggest headwind to the fixed income markets over the last few years has unequivocally been the Fed,” Gillum said, adding that with disinflation continuing at a steady pace, the central bank is likely finished with its monetary policy tightening.
Gillum also pointed out the asymmetric risk-return profile for bonds, thanks to the higher “yield cushion,” which can offset higher interest rates. This higher income component serves as a ‘hurdle rate’ that will need to be surpassed before further losses are realized.
Furthermore, he emphasized that bond investors could see equity-like returns without equity-like risks, as LPL Financial sees potential for high single-digit or low double-digit returns in the next 12 months for fixed-income investments.
In addition, the current fixed-income landscape is expected to open the door for income-oriented investors to generate income again, with the ability to build a high-quality portfolio of US Treasurys, AAA-rated mortgage-backed securities, and short-maturity investment-grade corporates without having to take on excessive risk to meet income needs.
As markets transition into a more normal rate environment, Gillum believes that bond investors are in a good position as 2023 comes to an end, acknowledging that while there may be volatility, the risk/reward for fixed income is as attractive as it’s been in some time.
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