After cutting the policy rate three times in 2019,

Jan 2020
Julianna Donovan

The Federal Reserve Open Market Committee voted unanimously in December to keep the short-term policy rate at 1.75%. With inflation low, economic growth positive and the labor market near full-employment, we believe the Fed has completed the “mid-cycle” adjustment, which Chair Jay Powell referenced in justifying his decision to lower rates. The stage is now set for a period of low and steady rates as the Fed will likely resist making further changes ahead of the general election in November 2020. While Fed policy has kept short rates low, it is returning to the market as a buyer of U.S. Treasury securities, having announced it is purchasing $60 billion a month of T-bills to alleviate funding pressure in the short-term money markets. Demand for U.S. government bonds from foreign buyers as well as broader investor demand for fixed income securities have also kept rates from rising very much. A staggering $12 trillion worth of foreign bonds now trade at negative yields – a perverse concept where investors are willing to accept some modest loss in order to maintain exposure to highly liquid, high quality assets. This phenomenon has resulted in increased demand for positive yielding U.S. government debt (thus supporting what is close to a $1.0 trillion fiscal account deficit the US was running). At the current rate of approximately 1.92%, the ten-year U.S. Treasury note is the highest yielding government bond among major developed markets. Despite such low yields, we believe bonds play an important role in client portfolios for several reasons. First, bonds provide an attractive cash substitute for spending needs or anticipated liabilities within a defined time horizon. Second, bond prices have historically tended to increase in times when stock prices decline, offering a diversification benefit. Third, bonds offer capital preservation and a steady income stream, reducing reliance on equities in periods when stocks might be under price pressure.

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