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What Could Fixed Income Investors Expect in 2018?

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NATHAN PETERSON: We’re fast approaching the end of the year and even though the Federal Reserve has been in tightening mode this year, 2017 has actually been a good year for fixed income investors. I’m Nathan Peterson, and, today, I’m joined with Kathy Jones, who will give us her outlook on fixed income as we move into 2018.

Kathy, thanks for much for joining us. So what can fixed investors expect as we move into the new year?

KATHY JONES: We think 2018 will probably be more challenging for fixed income investors than this year has been. In 2017, we benefited from steady-to-falling long-term yields and price appreciation in the riskier segments of the market—like high-yield and emerging market bonds. In 2018, we think investors might want to be a bit more cautious about where they look for yield. And there are three reasons for this.

First, is this long era of easy money from central banks is coming to an end. In fact, we may be past the peak of easy Central Bank policies already. The Fed has been raising short-term interest rates for the past year or so, and is in the process of reducing the size of its balance sheet. And the European Central Bank has reduced the pace of its bond-buying program, and may end it later this year. So easy money is on the way out. A somewhat tighter policy is on the way in.

Second reason is that inflation could actually surprise on the upside. It’s been a while since this has happened, but the global economy is growing at a very solid rate, and the unemployment rate in the U.S. is quite low, which could put some upward pressure on wages and inflation—at least more than the market is anticipating. And that’s fairly typical of the late stages of a business cycle.

And the third reason is that starting valuations are high. The extra yield you earn to take risk in the credit markets is low by historical standard, so there’s just not that much room for price appreciation from here.

We think there are a couple of steps that investors can take to mitigate some of the risk of rising interest rates in 2018. One would be to limit the average duration in a portfolio to the short- to intermediate-term. Somewhere in that three- to seven-year timeframe would probably give you some ability to earn income without taking too much duration risk.

And the second thing is to focus on higher credit quality bonds, where there’s less risk of price decline should we have a setback in the market. But, overall, rising interest rates can be good for bond investors. It’s been a long time since investors have been able to find attractive yields, without taking a lot of risk.

And we think as we move into this late stage of the business cycle, and the Fed continues to tighten policy, we might see that inflation. We could see some upward pressure on bond yields, which actually would allow investors who position a portfolio properly to take advantage of that rise in yields.

NATHAN: Really good information. Thanks so much for sharing your perspective today, Kathy.

For more, you can read the 2018 Schwab Market Outlook Report, where you can read up on additional views for the year ahead.

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.

Please note that this content was created as of the specific date indicated and reflects the author’s views as of that date. It will be kept solely for historical purposes, and the author’s opinions may change, without notice, in reaction to shifting economic, market, business, and other conditions.

Data contained herein from third party providers is obtained from what are considered reliable sources. However, its 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.

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. Lower rated securities, such as high yield securities, are subject to greater credit risk, default risk, and liquidity risk.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate this risk.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Investing involves risk including loss of principal.

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