Changing Landscape
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The current U.S. fixed income landscape presents a compelling case for tactical allocation. Short-term interest rates have declined following the U.S. Federal Reserve’s (Fed) latest rate cut with the federal funds rate hovering around 4.00-4.25% after a 0.25% reduction in September. This easing reflects cooling inflation and a softening labor market. However, long-term yields remain anchored higher with the 10-year Treasury yield at approximately 4.15% versus the 2-year at 3.63%, which has resulted in a steepening 10s-2s yield curve since April. In our view, this normalization signals expectations of further short-term interest rate reductions and keeping the 2-year yield low while sustained economic growth keeps the long end of the curve well anchored. Complementing this, credit spreads have tightened to historically narrow levels, with the ICE BofA US Corporate Index Option-Adjusted Spread at just 0.76% and high-yield spreads below 3.00% according to Fed data, which underscores the robust corporate health and investor confidence in credit quality.
In this environment, fixed income investing offers a rare trifecta: attractive income generation, capital appreciation potential, and relative safety. Falling short-term rates erode returns on cash equivalents, while a steepening curve rewards duration extension as longer-maturity bonds now yield a premium without excessive volatility risk. For investors seeking diversified, low-cost exposure, exchange-traded funds (ETFs) can deliver targeted access to these dynamics by blending passive efficiency with tactical yield enhancement.
Practical Solutions
Investors might consider an inexpensive aggregate bond ETF as part of a core allocation. These ETFs offer broad exposure to investment-grade securities, including Treasuries, mortgage-backed securities (MBS), and corporates. Their intermediate duration of about 6 years allows them to benefit from rate declines, delivering a 30-day SEC yield of nearly 4.5%. In a steepening curve, their blend of short- and long-end holdings captures roll-down returns while mitigating some reinvestment risk.
Building on the core allocation, we would add multi-sector bond ETFs that allocate across MBS, high-yield, and emerging market debt to leverage active management expertise and overweight undervalued sectors amid tight spreads. With yields above 5%, these ETFs can offer both attractive current income as well as the flexibility to adapt to the changing environment while still offering a ballast against equity market volatility.
Collectively, pairing core holdings with active ETFs can form a more resilient fixed income allocation. With the yield curve’s positive slope forecasting 1-2% annual carry advantage over cash, this type of allocation could generate 4-6% total returns annually along with hedging equity risks while preserving capital. For discerning investors, it’s a timely pivot from post-pandemic distortions toward normalized prosperity.
Focus on Fixed Income
The current and forecasted environment makes one thing clear: fixed income holdings must be a focus whether standalone or as part of an allocation. The dramatic changes in the rate environment demand a forward-looking approach in our option. Active professional management can be essential to navigate the risks, uncover relative value, and position the account to take advantage of what is shaping up to be one of the most significant shifts in the bond market in more than a decade.
Originally published by Stringer Asset Management
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DISCLOSURES
Any forecasts, figures, opinions or investment techniques and strategies explained are Stringer Asset Management, LLC’s as of the date of publication. They are considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect to error or omission is accepted. They are subject to change without reference or notification. The views contained herein are not to be taken as advice or a recommendation to buy or sell any investment and the material should not be relied upon as containing sufficient information to support an investment decision. It should be noted that the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested.
Past performance and yield may not be a reliable guide to future performance. Current performance may be higher or lower than the performance quoted.
The securities identified and described may not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable.
Data is provided by various sources and prepared by Stringer Asset Management, LLC and has not been verified or audited by an independent accountant.
