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2020 Market Outlook: Fixed Income

Key Points
  • Ten-year Treasury bond yields should move higher in 2020 as recession fears ease. Barring a setback on trade, yields could move back up to the 2.25% to 2.5% area.

  • The Federal Reserve is likely on hold for the foreseeable future. The three short-term rate cuts in 2019 successfully “un-inverted” the yield curve.

  • Investors should consider adding bonds with longer maturities to their fixed income portfolios if 10-year yields do move above 2.25%.

  • The value of the U.S. dollar should remain firm on continued outperformance by the U.S. economy relative to other major countries. However, further gains are likely to be small.

Easing recession fears should boost bond yields

Ten-year Treasury yields should move higher in 2020 as recession fears ease. The lagged impact of the Federal Reserve’s interest rate cuts, signs of stabilization in the global economy and a modest uptick in inflation expectations should provide a boost to intermediate- and long-term bond yields. The risk to our outlook is the ongoing threat of trade tariffs weighing on business investment. Barring further setbacks on trade, 10-year Treasury yields could move up to the 2.25% to 2.5% area, while the chances of a drop back below the 2019 low of 1.52% are diminishing as global recession fears abate.

With the yield curve now “un-inverted” and signs of economic stabilization, the Fed likely will be on hold for the foreseeable future.

 

Inflation expectations may rise

The key to higher yields on intermediate- to long-term bonds will be rising inflation expectations. With the economy showing resilience and core inflation edging up, inflation expectations should move higher, potentially adding 50 to 75 basis points¹ to 10-year Treasury yields. Breakeven inflation rates are low, so TIPS are attractive relative to nominal Treasuries for those looking for inflation protection.

Despite signs of economic stabilization, we see risks in the more aggressive segments of the bond markets, like high-yield bonds, bank loans and emerging market bonds. We suggest reducing exposure to high-yield bonds, while moving up in quality in the investment grade market. Municipal bond valuations have improved from early 2019 levels and still appear attractive for investors in higher tax brackets.

 

Takeaways

  • Treasury Inflation-Protected Securities (TIPS) appear attractive. Inflation expectations are low, making the inflation protection that TIPS provide relatively cheap.
  • Underweight high-yield bonds. The yield advantage they offer relative to Treasuries is low, while corporate profit growth poses a risk in 2020. Investors also should move up in quality in investment-grade corporate bonds, focusing on bonds with “A” ratings or above.
  • Consider higher-rated municipal bonds with maturities in the five- to eight-year range. Net supply of these bonds is likely to remain low, keeping prices from falling much.
  • Stay local. International bonds provide diversification, but not much yield. It would take a significant drop in the dollar to make up for the wide yield gaps.

What You Can Do Next

 

2020 Market Outlook: Global Stocks and Economy
Preferred Securities: Higher Yields, Different Risks

Important Disclosures:

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

Forecasts contained herein are for illustrative purposes, may be based upon proprietary research and are developed through analysis of historical public data.

All expressions of opinion are subject to change without notice in reaction to shifting market or economic conditions.

Data here are obtained from what are considered reliable sources; however, their accuracy, completeness, or reliability cannot be guaranteed. Supporting documentation for any claims or statistical information is available upon request.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Investing involves risk including loss of principal.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.

Tax-exempt bonds are not necessarily a suitable investment for all persons. Information related to a security’s tax-exempt status (federal and in-state) is obtained from third-parties and Schwab does not guarantee its accuracy. Tax-exempt income may be subject to the Alternative Minimum Tax (AMT). Capital appreciation from bond funds and discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.

Treasury Inflation Protected Securities (TIPS) are inflation-linked securities issued by the U.S. government whose principal value is adjusted periodically in accordance with the rise and fall in the inflation rate. Thus, the dividend amount payable is also impacted by variations in the inflation rate, as it is based upon the principal value of the bond. It may fluctuate up or down. Repayment at maturity is guaranteed by the U.S. government and may be adjusted for inflation to become the greater of the original face amount at issuance or that face amount plus an adjustment for inflation.

High-yield bonds and lower-rated securities are subject to greater credit risk, default risk, and liquidity risk.

Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. For more information on indexes please see www.schwab.com/indexdefinitions.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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