LPL: 2019 Outlook for Fixed Income

The environment for fixed income investors has been challenging over the last several years, and the struggle has intensified recently. As shown in the LPL Chart of the Day, long-term yields have fallen to 12-month lows, weighed down by plunging inflation expectations as fears of a global slowdown increase.

However, we see a disconnect between current rates and this year’s prospects for economic growth and inflation. As mentioned in our Outlook 2019, FUNDAMENTAL: How to Focus on What Really Matters in the Markets, we’re forecasting the 10-year Treasury yield will increase from current levels and trade within a range of 3.25—3.75% in 2019.

“Given our expectations for the economy, employment, slightly higher inflation, and balance sheet reduction, we look for market interest rates to move higher in the coming year,” said LPL Research Chief Investment Strategist John Lynch. Investors may have to endure periodic spikes and drops in rates, but we think this range is appropriate given the balance of Federal Reserve (Fed) guidance, U.S. Treasury issuance, wage pressures, and relative valuations.

Although markets may currently be pricing in a pessimistic outlook, we remain optimistic about U.S. economic growth prospects, and recent data show inflation remains at manageable levels. Because of this, we expect the data-dependent Fed to be less aggressive than initially feared as policymakers juggle these factors with the impacts of a stronger U.S. dollar and tepid global growth.

Against this backdrop, we expect near-flat returns for the Bloomberg Barclays U.S. Aggregate Bond Index in 2019. We continue to position portfolios with below-benchmark interest rate sensitivity and above-benchmark credit risk to help manage rising rates and position for continued economic growth.

As we move further into the business cycle, our bias is increasingly toward higher-quality debt, like investment grade (IG) corporates and mortgage-backed securities (MBS) for suitable investors. We believe IG corporates and MBS may provide some potential benefits from added quality-credit exposure while avoiding some of the risk of high yield.

For more of our forecasts, check out our Outlook 2019.

Source: https://lplresearch.com/2019/01/08/our-2019-outlook-for-fixed-income/