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The rate of inflation is near the Fed’s target, setting the stage for lower rates
What the Chart Shows:
The rate of inflation is getting closer to the Fed's target (dotted line). In fact, U.S. Headline inflation excluding shelter (green line) has been at roughly 2% annualized since May 2023.
What It Means for Investors:
Inflation is close to the Fed’s target. While this doesn’t mean prices are going down, they are rising less quickly, which is why the Fed plans to lower rates.
While still low relative to history, rising unemployment may support rate cuts from the Fed
What the Chart Shows:
How employment levels have ebbed and flowed over the last 50 years.
What It Means for Investors:
The Fed seeks to maintain stable prices and maximum employment. Rising unemployment is another indicator that may support the Fed's decision to lower interest rates.
Recession or not, bonds have historically performed well after rate hikes
What the Chart Shows:
Bonds have outpaced equities during a recession and still do well when the economy is strong.
What It Means for Investors:
After a central bank raises interest rates, the economy often enters a recession in the years that follow. Historically, bonds have performed well whether there’s a recession or not.
How many hiking cycles end in recession?
Figure is not indicative of the past or future results of any PIMCO product or strategy. There is no assurance that the stated results will be achieved.
* Recession (recession) is defined as having at least 2 quarters of sequential economic contraction, which occurs at some point within 4-years of the start of a rate hiking cycle. No recessions are everything else.
1 Countries used in the study for all DM landings since 1960 include: AU, BE, CA, FR, GE, IT, JP, NE, NZ, ES, SW, SE, UK, US. Before the EA was formed we use country specific policy rates. After the EA we use the ECB refi rate. Sample includes rate hiking cycles of at least 50bps cumulatively over 1-year, 14 developed market countries, from 1960 to today.
2 To produce estimated returns, we utilize the average shocks across the sample in Hard and No recessions measured over the 3-years following the peak CB rate. Equity returns are the average (local) price return annualized over 3-years. Bond and T-bill annualized returns are estimated by taking the average cumulative 3-year yield shocks (Cash: -1.6% No recession, -4.2% Recession; 10-Yr: -1.2% No recession, -1.4% Recession) and applying those to a current US T-bill and 10-year Treasury Bond. No representation is being made that these scenarios are likely to occur or that any portfolio is likely to achieve profits, losses, or results similar to those shown. The scenario does not represent all possible outcomes and the analysis does not take into account all aspects of risk. Total returns are estimated by re-pricing key rate duration replicating portfolios of par-coupon bonds. All scenarios hold OAS constant.
Starting Point: Bond yields are high
What the Chart Shows:
Current Yields (solid bars) versus yield two years ago (shaded bars) across fixed income sectors. Current yields are much higher in every sector.
What It Means for Investors:
Yields are still near decade highs across most fixed income sectors. The combination of high starting yields and expectations for rates to fall create an attractive outlook for a wide variety of bonds.
* Securitized Credit computed as average of CLOs, CMBS, and ABS from JPMorgan and Bloomberg.
** Municipal yields are the taxable equivalent yield, adjusted by the highest marginal tax rate (40.8%). Unadjusted IG Muni index yield is 3.4% with a change of 238bps compared to 12/31/2021 levels, the unadjusted HY Muni Index yield is 5.1% with a change of 243bps compared to 12/31/2021 levels.
1 The yield to worst is the yield resulting from the most adverse set of circumstances from the investor's point of view; the lowest of all possible yields.
Higher returns have historically followed higher yields
What the Chart Shows:
There is a 94% correlation between starting bond yields (blue) and forward returns (green), suggesting that future bond market returns closely follow starting yields.
What It Means for Investors:
With starting yields nearly two times higher than the average yield since 2010, investors could stand to benefit from attractive return potential in fixed income investments going forward.
Given long-term returns follow starting yields
As of 30 September 2024. SOURCE: Bloomberg, PIMCO. Yield and return are for the Bloomberg U.S. Aggregate Bond Index. It is not possible to invest directly in an unmanaged index.
As cutting cycles begin, a reversal in fixed income returns has tended to follow
What the Chart Shows:
Trailing 12-month return on a diversified fixed income portfolio compared to cash in months before and after the end of hiking cycles since 1980. Green (red) bars show outperformance (underperformance) versus cash.
What It Means for Investors:
At this point in interest rate cycles, bonds have tended to outperform cash. Fed rate cuts have historically supported fixed income performance while also eroding cash returns.
1 Cutting cycles are defined as periods where the Federal Reserve embarks on a sustained path of increasing the target Fed Funds rate and/or target range. We define the end of a cutting cycle as the month where the Fed reaches its peak policy rate for that cycle (i.e., it either pauses rate hikes or cuts). Cutting cycles include (start to peak), 1980 (Jul '80 to May '81), 1983 (Feb '83 to Aug '84), 1988 (Feb '88 to Mar '89), 1994 (Jan '94 to Feb '95), 1999 (May '99 to May '00), 2004 (May '04 to Jun '06) and 2015 (Nov '15 to Dec '18).
Rate cuts are an attractive time to invest cash into bonds, history shows
What the Chart Shows:
Short- and longer-term yields behave differently right before the Fed cuts rates - and after.
What It Means for Investors:
Following the first Fed cut, cash yields have tended to decline dramatically. However, bonds yields also have tended to fall meaningfully, providing an opportunity for investors willing to step out of cash allocations sooner.
Cutting cycles start: 30 June 1981, 30 September 1984, 31 May 1989, 30 June 1995, 31 December 2000, 30 September 2007, and 31 July 2019.
Many fixed income sectors historically outperform following the Fed cuts
What the Chart Shows:
Average cumulative returns 1-year before and 3-years after the start of past cutting cycles. Cash outperforms initially in cutting cycles as rates fall; however, once they conclude outperformance across many fixed income sectors is broad-based.
What It Means for Investors:
Investors sitting in cash seeking higher yields today may want to consider the return potential versus risk of other fixed income sectors going forward.
Fixed income performance across cutting cycles
While yields have decreased modestly from their peak, there may still be room to rally
What the Chart Shows:
Left graph shows changes in interest rates in 24-months after the end of past hiking cycles. Right graph shows resulting returns for core bonds, as represented by the BBG US Aggregate Index.
What It Means for Investors:
We are likely at the stage of the hiking cycle where investors in traditional fixed income historically outperform cash. Investors sitting in cash may want to consider the return potential versus risk of other fixed income sectors.
Hiking cycles are defined as periods where the Federal Reserve embarks on a sustained path of increasing the target Fed Funds rate and/or target range. We define the end of a hiking cycle as the month where the Fed reaches its peak policy rate for that cycle (i.e., it either pauses rate hikes or cuts). Hiking cycles include (start to peak), 1980 (Jul '80 to May '81), 1983 (Feb '83 to Aug '84), 1988 (Feb '88 to Mar '89), 1994 (Jan '94 to Feb '95), 1999 (May '99 to May '00), 2004 (May '04 to Jun '06) and 2015 (Nov '15 to Dec '18).
Why Yield Matters: Higher yields anchor return potential across a range of scenarios
What the Chart Shows:
Estimated 12-month total returns for various segments of the bond market under different yield environments, from a 3% decline to a 3% increase.
The red boxes show scenarios for negative returns, white boxes show flat returns and green boxes highlight positive returns.
What It Means for Investors:
High quality and diversified portfolios, like Core Plus, investment grade municipals, and multisector, offer higher return potential across most rate outcomes. If rates do fall as forecasted, these sectors are poised to meaningfully outperform cash and T-bills.
Estimated 12-month return by fixed income sector under different yield shocks
T-bills: BofA 3Mo. T-bill Index, Ultrashort: Morningstar Ultrashort Bond Category, Short-term: Morningstar Short-term Category, Multisector: Morningstar Multisector Bond Category, Core Plus: Morningstar Intermediate Core Plus Category, IG Muni: Bloomberg Municipal Index, Long Treasury: BBG US Long Treasury Index..
1All yield curve shocks above are specified in a parallel fashion and adjust each tenor in the same magnitude. In the analysis contained herein, PIMCO has outlined hypothetical event scenarios which, in theory, would impact the yield curves as illustrated in this analysis. No representation is being made that these scenarios are likely to occur or that any portfolio is likely to achieve profits, losses, or results similar to those shown. The scenario does not represent all possible outcomes and the analysis does not take into account all aspects of risk. Total returns are estimated by re-pricing key rate duration replicating portfolios of par-coupon bonds. All scenarios hold OAS constant.
When stocks decline, bonds have provided attractive returns
What the Chart Shows:
For the last 95 years, with few exceptions, bonds have provided positive returns when stocks were in negative territory.
What It Means for Investors:
Bonds have historically provided positive returns in years when stocks are negative. While a historic inflation surprise drove both stocks and bonds lower in 2022, we expect bonds to continue to diversify during equity down markets as they have for nearly a century.
The Active Advantage: Passive may make sense for equities, but bonds are different
What the Chart Shows:
The importance of active management in fixed income is shown by the percentage of active funds that have outperformed: 80% of active bond managers outperformed, while only 14% of active equity managers did.
What It Means for Investors:
Bonds are different because of the complexity of the fixed income market and the structural opportunities that skilled active managers can take advantage of, which has led them to outperform their passive peers.
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Disclosures
Past performance is not a guarantee or a reliable indicator of future results.
Charts are provided for illustrative purposes and are not indicative of the past or future performance of any PIMCO product.
All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Income from municipal bonds is exempt from federal income tax and may be subject to state and local taxes and at times the alternative minimum tax. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Diversification does not ensure against loss.
Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.
Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve.
Hypothetical illustrations have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve results similar to those shown. In fact there are frequently sharp differences between hypothetical results and actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical results is that they are generally prepared with the benefit of hindsight. In additional, hypothetical scenarios do not involve financial risk, and no hypothetical illustration can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation if any specific trading program which cannot be fully accounted for in the preparation of a hypothetical illustration and all of which can adversely affect actual results.
Return assumptions are for illustrative purposes only and are not a prediction or a projection of return. Return assumption is an estimate of what investments may earn on average over the long term. Actual returns may be higher or lower than those shown and may vary substantially over shorter time periods.
Stress testing involves asset or portfolio modeling techniques that attempt to simulate possible performance outcomes using historical data and/or hypothetical performance modeling events. These methodologies can include among other things, use of historical data modeling, various factor or market change assumptions, different valuation models and subjective judgments.
The option adjusted spread (OAS) measures the spread over a variety of possible interest rate paths. A security’s OAS is the average earned over Treasury returns, taking multiple future interest rate scenarios into account.
Morningstar Categories: Corporate Bond portfolios concentrate on bonds issued by corporations. These tend to have more credit risk than government or agency-backed bonds. These portfolios hold more than65% of their assets in corporate bonds, hold less than 40% of their assets in foreign bonds, less than 35% in high yield bonds, and have an effective duration of more than 75% of theMorningstar Core Bond Index. Intermediate-term core bond portfolios invest primarily in investment-grade U.S. fixed-income issues including government, corporate, and securitized debt, and hold less than 5% in below-investment-grade exposures. Intermediate-term core-plus bond portfolios invest primarily in investment-grade U.S. fixed-income issues including government, corporate, and securitized debt, but generally have greater flexibility than core offerings to hold non-core sectors such as corporate high yield, bank loan, emerging-markets debt, and non-U.S. currency exposures. Their durations (a measure of interest-rate sensitivity) typically range between 75% and 125% of the three-year average of the effective duration of the Morningstar Core Bond Index. Large Blend portfolios are fairly representative of the overall U.S. stock market in size, growth rates, and price. Stocks in the top 70% of the capitalization of the U.S. equity market are defined as large cap. The blend style is assigned to portfolios where neither growth nor value characteristics predominate. These portfolios tend to invest across the spectrum of U.S. industries, and owing to their broad exposure, the portfolios' returns are often similar to those of the S&P 500 Index. Multisector bond portfolios seek income by diversifying their assets among several fixed-income sectors, usually U.S. government obligations, U.S. corporate bonds, foreign bonds, and high-yield U.S. debt securities. These portfolios typically hold 35% to 65% of bond assets in securities that are not rated or are rated by a major agency such as Standard & Poor's or Moody's at the level of BB (considered speculative for taxable bonds) and below. Muni national long portfolios invest in bonds issued by various state and local governments to fund public projects. The income from these bonds is generally free from federal taxes. To lower risk, these portfolios spread their assets across many states and sectors. These portfolios have durations of more than 6.0 years (or average maturities of more than 12 years). Short-term bond portfolios invest primarily in corporate and other investment-grade U.S. fixed-income issues and have durations of one to 3.5 years (or, if duration is unavailable, average effective maturities of one to four years). These portfolios are attractive to fairly conservative investors, because they are less sensitive to interest rates than portfolios with longer durations. Ultrashort-bond portfolios invest primarily in investment-grade U.S. fixed-income issues and have durations typically of less than one year. This category can include corporate or government ultrashort bond portfolios, but it excludes international, convertible, multisector, and high-yield bond portfolios. Because of their focus on bonds with very short durations, these portfolios offer minimal interest-rate sensitivity and therefore low risk and total return potential. Morningstar calculates monthly breakpoints using the effective duration of the Morningstar Core Bond Index in determining duration assignment. Ultrashort is defined as 25% of the three-year average effective duration of the MCBI.
©2024 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.
Bloomberg U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis. Bloomberg U.S. MBS Fixed-Rate Index covers the mortgage-backed pass-through securities and hybrid ARM pools of Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The MBS Index is formed by grouping individual fixed rate MBS pools into generic aggregates. Bloomberg Municipal Bond Index consists of a broad selection of investment-grade general obligation and revenue bonds of maturities ranging from one year to 30 years. It is an unmanaged index representative of the tax-exempt bond market. The index is made up of all investment grade municipal bonds issued after 12/31/90 having a remaining maturity of at least one year. The Bloomberg High Yield Municipal Bond Index measures the non-investment grade and non-rated U.S. tax-exempt bond market. It is an unmanaged index made up of dollar-denominated, fixed-rate municipal securities that are rated Ba1/BB+/BB+ or below or non-rated and that meet specified maturity, liquidity, and quality requirements. The Bloomberg US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. FTSE 3-Month Treasury Bill Index is an unmanaged index representing monthly return equivalents of yield averages of the last 3 month Treasury Bill issues. The ICE BofA 3 Month U.S. Treasury Index measures the performance of a single issue of outstanding treasury bill which matures closest to, but not beyond, three months from the rebalancing date. Bloomberg U.S. Credit Index is an unmanaged index comprised of publicly issued U.S. corporate and specified non-U.S. debentures and secured notes that meet the specified maturity, liquidity, and quality requirements. To qualify, bonds must be SEC-registered. This index was formerly known as the Bloomberg Credit Investment Grade Index. The Bloomberg U.S. Treasury Long Index measures the performance of public obligations of the U.S. Treasury with maturities of 10 years and greater, including securities that roll up to the U.S. Aggregate, U.S. Universal, and Global Aggregate Indices. J.P. Morgan Emerging Markets Bond Index (EMBI) Global tracks total returns for United States Dollar denominated debt instruments issued by emerging market sovereign and quasi-sovereign entities: Brady bonds, loans, and Eurobonds. It is not possible to invest directly in an unmanaged index. S&P 500 Index is an unmanaged market index generally considered representative of the stock market as a whole. The Index focuses on the large-cap segment of the U.S. equities market. It is not possible to invest directly in an unmanaged index.
PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This material contains the current opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America LLC. in the United States and throughout the world.
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