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Q2 2024 Global Fixed Income Outlook

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Multi-colored international currency.

The Clock Is Ticking: Fed’s Pending Policy Shift Highlights Opportunities

Federal Reserve (Fed) policymakers have held the federal funds rate target steady since July 2023. Then, in December, they penciled in three rate cuts for 2024, confirming their interest rate target had peaked. As such, Fed policy is nearing an inflection point, which we believe brings certain fixed-income opportunities into focus.

Bonds Have Historically Delivered Robust Results After the Fed Stopped Hiking

As history demonstrates, once the federal funds rate reached its cycle peak, bonds delivered solid returns in the subsequent one-year periods. See Figure 1. This was likely due to investor expectations for the Fed to eventually follow up its tightening cycle with rate cuts.

Figure 1 also shows that bond performance was much more consistent than stock performance in the post-peak-rate periods. While stock returns were strong in several periods, they also suffered steep losses in others.

Figure 1 | Peak Interest Rates Consistently Led to Strong One-Year Returns for Bonds

Federal Funds Peak Rate Date

Bloomberg U.S. Aggregate Bond Index

S&P 500 Index

3/1/1980

10.51%

31.21%

12/1/1980

13.39%

-2.07%

8/1/1984

23.91%

14.50%

2/24/1989

12.80%

15.89%

2/1/1995

16.95%

14.71%

5/16/2000

13.78%

-17.85%

6/29/2006

6.35%

-18.86%

12/19/2018

8.99%

22.19%

One-Year Returns From Peak

Average Return

13.34%

7.48%

Standard Deviation

5.01%

17.26%

Data from 3/1/1980 – 12/31/2023. Source: FactSet.

Today’s Market Is Tracking Previous Years’ Trends

We expect Treasury yields to follow the patterns of prior post-rate-hike cycles and decline this year. Accordingly, we expect duration in high-quality bond portfolios to contribute additional total return beyond the yield. We believe that today's yield environment is attractive and provides a good starting point for solid total return potential.

Reinvestment Risk Is Rising

The Fed’s aggressive rate-hike campaign lifted yields on money market funds and other high-quality, short-maturity investments to multiyear highs. This led to hordes of cash flowing into these securities. Assets in U.S. money market funds climbed to a record-high $6 trillion in early 2024.1

Once the Fed starts easing, money market yields, which are sensitive to Fed policy, will also downshift. Similarly, yields across all bond maturities will likely decline, and bond prices should rise.

Reinvesting cash assets into the bond market may become more expensive as Fed policy pivots. Shifting cash exposure to high-quality, intermediate-maturity bonds ahead of potential rate cuts may help secure attractive performance potential. In our view, these securities offer the opportunity to lock in what we feel are attractive yields and promising total return potential once the Fed begins easing.

Quality, Duration Remain Key Considerations

Overall, we remain selective and focused on higher-quality bonds. We continue to favor a modest duration overweight, given our outlook for the economy to slow and the Fed to cut rates.

U.S. Government

We believe Treasury yields will likely remain volatile amid near-term uncertainty surrounding Fed policy, economic data and inflation. But the Fed has reached a turning point, and the economy will likely slow. Therefore, we expect yields — especially those in the short/intermediate-maturity range — to fall and ultimately stabilize. Against this backdrop, we see value in modestly extending duration.

U.S. Securitized

We expect agency mortgage-backed securities (MBS) valuations to remain range-bound amid Fed policy uncertainty. Nevertheless, we continue to overweight the sector. We believe the agency MBS sector still offers relative value versus other sectors, especially given its high quality and relative protection from broader market volatility. Among credit-sensitive subsectors, we favor higher-quality, shorter-duration securities and seek to remain invested amid heavy demand. We remain respectful of the strong technical backdrop while rotating toward subsectors with solid fundamentals.

U.S. Corporate

We continue to favor higher-quality corporates and are finding value among large banks and utilities. We remain somewhat defensive, given our view that valuations are stretched and vulnerable to slowing fundamentals. We don’t believe higher interest rates have fully filtered through the economy, which could further pressure valuations. In our view, a slowing economy will ultimately drive investment-grade and high-yield credit spreads wider, providing more attractive buying opportunities.

Municipal

We believe the relatively high quality and longer duration of municipal bonds should bode well for the asset class as the economy slows. We expect municipal credit fundamentals to remain durable, supported by reserve fund balances and conservative budgeting practices. States that rely heavily on personal income taxes will likely continue to experience declining revenues. We generally favor higher-quality issuers and sectors and believe security selection remains crucial to performance, particularly among high-yield issuers.

Money Markets

With the market slashing its expectations for Fed rate cuts, the “higher for longer” theme is taking hold. Accordingly, we favor floating-rate instruments over fixed coupons. Amid new U.S. Securities and Exchange Commission (SEC) regulations, we are implementing barbell allocations, whereby half of our portfolios’ assets must be liquid within seven calendar (five business) days. Accordingly, we expect to be significantly overweight U.S. Treasuries (most noticeable in non-government money market funds), which fulfill the SEC’s higher liquidity demands.

Non-U.S. Developed Markets

Amid better valuations, we have been increasing our duration posture in commodity-rich countries such as Norway, Canada and New Zealand. We believe rates and currencies in these countries provide a cushion against geopolitical risks that could push up global inflation expectations and trade costs. In our view, expectations for rate hikes or delayed cuts, stronger debt fundamentals and the absence of national elections make these countries attractive. However, we will remain vigilant in managing currency risks, as commodity currencies are sensitive to geopolitical flare-ups. Our corporate exposure continues to favor higher-quality sectors.

Emerging Markets

We expect a favorable environment for local currency emerging markets (EM) bonds and rates. EM central banks have already brought down core inflation faster than central banks in developed markets. Meanwhile, global growth should decline as the U.S. starts to feel the pain of its aggressive rate-hike cycle. So should U.S. rates, which should reduce the pressure on EM rates. We think this will allow EM central banks to start easing earlier and faster than the Fed, thereby providing positive return potential from duration.

John Lovito
John Lovito

Co-Chief Investment Officer

Global Fixed Income

Charles Tan
Charles Tan

Co-Chief Investment Officer

Global Fixed Income

¹Investment Company Institute, all taxable and tax-exempt money market funds as of January 31, 2024.

Explore Our Global Fixed Income Capabilities

References to specific securities are for illustrative purposes only and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.

International investing involves special risks, such as political instability and currency fluctuations. Investing in emerging markets may accentuate these risks.

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

Historically, small- and/or mid-cap stocks have been more volatile than the stock of larger, more-established companies. Smaller companies may have limited resources, product lines and markets, and their securities may trade less frequently and in more limited volumes than the securities of larger companies.

Diversification does not assure a profit nor does it protect against loss of principal.

Generally, as interest rates rise, bond prices fall. The opposite is true when interest rates decline.

Past performance is no guarantee of future results. Investment returns will fluctuate and it is possible to lose money.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.